Introduction

Investment strategies that sit between passive and highly active management have gained increasing attention from investors. Often referred to as enhanced indexing, active indexing or smart beta, these approaches combine features of both investment styles.

Enhanced indexing strategies are typically priced close to passive products and are often offered through ETF structures, while still employing an alpha-generating investment process. Their objective is to outperform a reference index consistently by a modest margin, net of fees.

For investors favoring passive strategies, the attraction lies in the potential to match or modestly exceed index returns while keeping fees and deviation risk comparatively low. For active investors, enhanced indexing offers a lower-risk alternative with a higher probability of generating positive excess returns, albeit on a smaller scale.

Investment Concept

The objective of an enhanced indexing (EI) strategy is to outperform the reference index consistently by a small margin after fees. These strategies typically target annual excess returns of around 0.5–1% with a tracking error of approximately 1–1.5%. Information ratio targets, defined as excess return divided by tracking error, generally range between 0.5 and 1.

Many EI strategies use the same alpha model as their more active counterparts, particularly in quantitative investing. The key difference lies in implementation. Lower tracking error targets require a larger number of smaller active positions, leading to greater diversification of active risk.

This diversification tends to produce more stable relative performance, making prolonged periods of underperformance both less frequent and less severe. Recovery from periods of weak relative performance is therefore often faster. EI strategies also typically exhibit lower portfolio turnover than highly active strategies.

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