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James, a portfolio analyst working for an Australian superannuation fund, is tasked to create a bespoke index that measures the performance of Australian consumer staple
James, a portfolio analyst working for an Australian superannuation fund, is tasked to create a bespoke index that measures the performance of Australian consumer staple sector between 1999 and 2019. The portfolio managers of the fund are only interested in the companies in the All Ordinaries Index (the largest 500 companies listed on the Australian Securities Exchange) and need the market-cap weighted daily return for the Index. To construct the index, James did the following steps. Step 1: James downloaded the historical constituent companies of the All Ordinaries Index between 1999 and 2019. He then found the daily price, return and market capitalization information of all the companies ever appeared in the index. Step 2: James then joined the list of companies he found in Step 1 with the latest GICS classification to identify companies in the consumer staple sector. Step 3: Using the list of stocks selected from the previous step, for each day , James calculated the market cap of a stock as the closing price on day multiplied with the number of shares outstanding on day. He then used a stock's market cap divided by the market cap of all stocks on day to calculate the weight of a stock in the index. Lastly, he multiplied the weight with the return of each stock on day and summed the values to obtain the market-cap weighted return for the index on day. Critique the process James used to create the index. Specifically, for each issue, please use the following bullet format to answer the question: Identify the issue Potential bias introduced The impact on the resulting index
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