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Can anyone please explain how fixed income index are actually replicated (in an ETF) by asset managers ? I looked online, everyone says they do sampling (stratified sampling) which makes sense but I would like to read a bit more details.

I can see the variables to be considered can be so many:
Duration, Credit Quality, Coupon, Maturity, Country, Type (CB, Straight, Covered)

Of course in the case of equity, to economize cash people trade futures. How does this work in case of Bonds. Do they trade Bond Futures, Swaps ?

Any experience or resource would be highly appreciated.

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  • $\begingroup$ Why would an asset manager replicate an ETF? I think more often they are looking to replicate an index although it might come to the same. ETF market makers would want replicate ETF's so they can create ETF shares. $\endgroup$
    – Bob Jansen ♦
    Nov 30, 2020 at 12:25
  • $\begingroup$ Hello, Updated the question. I see we are on the same pages. $\endgroup$
    – user3426614
    Nov 30, 2020 at 12:38

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In practice, the ETF sponsors have "proxy baskets" that have 30-40 issues they will accept in lieu of a full replicated basket to create or redeem. However, the specific issues in the proxy basket are not publically available and generally only available to "authorized participants" In practice, it is just not reasonable to fully replicate a basket of ~700 issues due to liquidity constraints.

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  • $\begingroup$ Thanks and I agree. Though I would to understand how they choose which one to trade to be honest. To my kno. the main objective of ETF is to keep low TE rather than performance. So there must be a broad policy/methodology to do this isnt it ? $\endgroup$
    – user3426614
    Dec 1, 2020 at 15:38

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