Replication Strategies

Replication strategies are used by portfolio managers who want to track the performance of a certain index. There are various replication methods, and which one to choose depends on the investment strategy and risk tolerance. 

Full replication is a straightforward replication strategy where a fund manager would buy every security that makes up an index at the same weights as the index. Typically, full replication is done with liquid securities. The physical replication of portfolios or investable indices minimizes the chances of tracking error and should give the same return as the index it’s tracking.  

Sampling is similar to full replication, except the portfolio is only made up of a select number of securities from the underlying index it is tracking. The selection corresponds with the level of risk a manager is willing to take on, and sampling is helpful in providing a representative portfolio of the overall index that is based on computer driven portfolio optimization methods. 

Synthetic replication is a replication strategy that employs derivatives to track an index. Instead of buying all of the securities in an index like in full replication, the manager would enter into a swap contract that will pay the index return for a flat fee. The benefit of synthetic replication is the fund does not take on any purchasing or selling expenses. 

For more information on Replication Strategies please contact INDICES@HFR.COM

Examples of HFR Indices that employ Replication Strategies are listed below: