What aspect does pure indexing focus on in portfolio management?

Pure indexing in portfolio management is fundamentally about replicating the performance of a specific benchmark index. The essential aspect of pure indexing is that it aims to achieve an active return of zero, meaning that the strategy does not seek to outperform the index but rather to match its performance as closely as possible. In doing so, the active risk—commonly defined as the standard deviation of the difference between the portfolio's returns and the benchmark's returns—is also minimal or zero.

This approach contrasts markedly with active management strategies, where the investment aims to create a positive (or negative) active return through selection of stocks or market timing. In pure indexing, the goal is to eliminate as much active risk as possible, therefore providing a clear relationship between the portfolio's performance and the benchmark's performance. By achieving a zero active return, investors can also benefit from lower management fees and transaction costs associated with frequent trading.

In contrast, strategic asset allocation involves a broader view that may include diversifying across multiple sectors, while high-frequency trading strategies focus on rapid trading to capitalize on small price movements. Derivative-heavy instruments, on the other hand, may be used in more complex strategies aimed at hedging or enhancing returns, which deviates from the core focus of pure indexing.