your question isn't clear

Emlyn,

Your query is kinda hazy but let me see if I can be of help...

When an investor builds up their portfolio based on a certain benchmark (such as NASI), there will be minimal tracking risk - as the performance of the portfolio is expected to track the performance of the benchmark.

When an investor has certain expectations or needs based on their experiences (what you are referring to as heuristic judgements), they could design their portfolio based on what their knowledge/experience.

That could increase the tracking risk if there are significant deviations between what the portfolio holds and the benchmark contains.

So, its really about handling the investor's heuristic judgments so as to minimise tracking risk.

Hope this helps.

Regards

Kamae Gai wa matuiní....come srowry.

Hi Emlyn,

When an investor decides to invest in either an index fund (or buy the shares in the index), they do so in the belief that the market is already effecient. Hence, there will be no need for one to deviate from the index weightings to gain additional return (alpha).

The success of such an investor would therefore be how closely related their return is related to the index return. Another success factor is their tracking risk - and if you combine the two is the active ratio.

As regards balancing, you would rarely expect the investor to rebalance their portfolio. One reason is that there are few instances where when a share is being added,replaced or deleted from the index.

Assuming that you have the NSE 20 as your benchamrk index, you would have decided to replace CMC Holdings by Uchumi Supermarkets today. NSE decided to make that change yesterday - on 8 December 2011 (See the media centre section on the NSE website).

The other instance would be incase of a corporate action such as exercing a rights issue - only if the action would not materially affect the weighting of that share in the index.

FYI, the index would automatically adjust for other corporate actions like a bonus share issue or stock split.

Hope this helps.

Regards

Emlyn,

It is true that such automatic adjustments could necessitate rebalancing.

But what I have seen over time is that an investor would initially decide to set a tolerance limit for any share in the index.

For instance, if the percentage holding for Uchumi within the index is 2.5%, then an investor may allow the holding to vary between 2% and 3% of the portfolio.

That way, one avoid many instances of rebalancing of the index thereby reducing transaction costs and net returns.

Regards

This is one of those threads that I can't contribute. But it is enlightening all the same.

Thanks scooby.

do we have an active or passive bond market index in kenya (running)?

@scooby. I have seen AA track the bond market by looking at changes in clean price. They've taken clean prices based on the NSE yield curve and weighted them based their respective liquidity. Off course they only look at what is tradable over the NSE (excluding those bonds whose prices can't be determined through the NSE). According to AA the Kenyan bond mart is priced at 89% of face value. What do you think?

Hi Scubidu,

My interpretation of what you are asking is whether AA’s assertion that the market prices of the bonds are understated is true. That being the case, there are two things that we can consider.

Firstly, the value of bonds in Kenya is largely attributed to the level of government borrowing and the consistent election cycle like the current pre election jitters. So, how comfortable are they that the clean prices for tradeable securities are purely driven by market forces?

I remember that we were talking, a while ago, about the HF bond that has an interest rate of 8.5% for the fixed rate portion. If you look at today's bond pricelist (i.e. 22 December 2011), the last clean price for that bond was 100 implying the yield for this bond is 8.5%.

In contrast, the latest NSE yield curve (as of 16 December 2011) indicates that the yield for a six year bond is 14.376%. So the “market price” for the fixed portion of the HF bond should far much lower than 100.

Secondly, I'll be curious as to how they derive their yield curve i.e. do the use on the run (recently issued), off the run (old issues) or a mixture of both. Tell me if they do have yields for, say, six or seven years.

Let me know what your views are on what I have mentioned.

Regards

@scooby

passive strategies are designed to make a return that does not beat the market. so buy and hold strategies are clinically designed for that purpose (for both bonds and equities). aren't they?