When Credit Suisse and S&P both recently announced 130/30 “indices”, we struck a note of skepticism.  Wasn’t such an active index an oxymoron?  Doesn’t a short-extension simply leverage a manager’s pre-existing alpha?  And if so, isn’t such an index just an arbitrary benchmark based upon the underlying alpha-generation model?

Andrew Lo provided some arguments in favour of such an index in his December 2007 paper “130/30: The New Long-Only“.  In it, he acknowledges:

“our proposal to put forward an algorithm or dynamic portfolio as an index is a significant departure from the norm. Existing indexes such as the S&P 500 are defined as baskets of securities that change only occasionally, not dynamic trading strategies requiring monthly rebalancing.  Indeed, the very idea of monthly rebalancing seems at odds with the passive buy-and-hold ethos of indexation.”

According to a paper published in the January 2008 edition of the Journal European Financial Management, the “passive buy and hold ethos of indexation” ain’t so passive after all.  The paper (earlier version available here), finds that most indices are chalked full of active biases – making a truly passive index a rare animal indeed.  This, of course, is the central argument made by proponents of fundamental indexation (see related posting, “Arnott: Does My Beta Produce Alpha?”)

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