Passive management is most common on the equity market, where index funds track a stock market index. Today, there is a plethora of market indexes in the world, and thousands of different index funds tracking many of them.
Rationale
Implementation
Metrics
At the simplest, an index fund is judged on it's "tracking error". This is defined as the annualised standard deviation of the [tracking error]? between the returns on the index fund and the returns on the index that it is supposed to replicate. Tracking error is computed using the following steps:
Tracking error is the standard deviation of the random variable, which is the error between index fund return and TR index return over one year. Assuming this error is normally distributed, we can then make inferences such as "The actual error is likely to be smaller than twice the tracking error with a 95% probability". For example, if an index fund exhibits a tracking error of 0.3%, then we can be 95% sure that over a one--year period, the error between the index fund returns and the TR index will be smaller than 0.6%.
Tracking error penalises discrepencies between the index fund and the index, but it does not directly concern itself with portfolio strategies which obtain systematically higher or lower returns. These include fees, riskless efforts to obtain superior returns such as stocklending, and index arbitrage, etc. Hence, an alternative measure that is often preferable in judging index funds is the "information ratio", which is defined as the [Sharpe's Ratio]? of the error time-series. It is the reward divided by risk, i.e. it is the average outperformance of the index fund divided by the tracking error.
Taxonomy
Further reading
Related entries -- [index construction]?, [active management]?, [performance evaluation]?, [fees and expenses in fund management]?, Vanguard?, [State Street]?, [Barclays Global]?, [[Standard & Poors]], [[S&P 500]], [index futures]?, [Pension fund management]?.