What Is an Enhanced Index Fund (EIF)?
An enhanced index fund is a fund that seeks to enhance the returns of an index by using active management to modify the weights of holdings for additional return.
Understanding Enhanced Index Funds (EIF)
Enhanced index funds are constrained to investing in securities from the index they are benchmarking. These strategies can deploy various types of investment analysis. They may utilize qualitative and quantitative methodologies to identify and overweight top-performing stocks. In some cases, they may also use leverage and derivatives to enhance returns.
Enhanced Index Fund Strategies
Enhanced index funds can be benchmarked to any index in the world. They begin with the benchmark index as a basis for investment. Through qualitative and quantitative analysis, portfolio managers seek to identify top performing stocks, which then receive greater weight in the portfolio. Some funds may use leverage and derivatives, allowing the funds to increase the weights of stocks they choose to buy and decrease the weights of stocks they choose to sell.
With leverage, funds can take deeper long positions in stocks they favor. Leverage and derivatives also allow the fund manager to short stocks they believe will trend lower. Fund managers may also take no position in a stock, giving it a weighting of 0% in the portfolio.
Theoretically, the ability to take both long and short positions should help a fund to generate additional alpha from potential stock gains and losses. However, the use of leverage and derivatives can add additional costs and increase the potential for losses. Therefore most enhanced index funds rely on active management methodologies built around a specific index universe without the use of alternative investing.
Enhanced Index Fund Investments
While enhanced index funds use the same index universe for investment as passive funds, their investing characteristics will be very different. Enhanced index funds typically have higher management fees and higher transaction costs than comparable index funds. Risks can also be higher depending on leverage and derivatives used.
Investors will find enhanced index fund offerings from investment managers across the industry, with most of the largest asset managers offering a broad range of enhanced index fund products. The Fidelity Large Cap Value Enhanced Index Fund provides one example.
The Fidelity Large Cap Value Enhanced Index Fund
The Fidelity Large Cap Value Enhanced Index Fund seeks to enhance the return of the Russell 1000 Value Index. The Fund uses quantitative fundamental analysis in its investment decisions, investing at least 80% of assets in Russell 1000 Value stocks. The Fund does not substantially rely on leverage or derivatives in its management strategy. The Fund has steadily outperformed the Russell 1000 Value since inception with a return of 6.29% versus 6.17% for the Index.