Beating The Market With Enhanced Index Funds

With time, new instruments are coming to the financial markets which are supposed to be more liquid, more flexible, more profitable and/or less risky. Enhanced Index Funds or EIF are one of these new products which enable traders to get above normal return from markets.

Enhanced index funds are mutual funds which fall into the category of Active Index Funds or AIF. These index funds try to outperform the normal index funds by active management of the fund portfolio. EIFs try to beat the market by many means.

• By carefully managing the position sizes or allocation to a index or sector.
• By fine-tuning the market entry and exit timings.
• By investing only in certain securities of the index which satisfy certain rules.
• By avoiding certain securities which are prone to underperformance.
• By carefully utilizing the leverage and other tools.
• By periodically (often) changing the portfolio allocations and investment preferences with change in market performances or trends.

EIFs trades just like any other index funds but they have two important differences associated with them. First is they involve management risk – the risk arise as a result of (ineffective) active fund management. All normal index funds have only market risk – risk arise as a result of market volatility – but EIF have both market and management risks. Second is the high fee. Although lower than most mutual funds, EIFs have higher fees associated with them than normal index funds. This is because the active management of the portfolio requires higher fees (more buying and selling).

Investing in EIFs can offer both advantages and disadvantages.

Advantages of EIFs

• Higher return than most other index funds.
• Increased portfolio diversity and less risk as you are investing in a broad index.
• Lower expense ratio than most mutual funds.
• Suitable for all type of investors.
• Advantages from semi-active fund management which enable investors to profit from changing market conditions.

Disadvantages of EIFs

• More risk than normal index funds.
• High expense ratio than index funds.
• No sufficient performance history available as they are newer instruments.
• Risk of losing capital because of ineffective fund management.

Investors are advised to carefully choose EIF after properly understanding the funds asset allocation and active management strategies.