Asset allocation is one of the most important stages in building an investment portfolio, therefore it is easy to see why investors would be attracted to enhanced index strategies that straddle the divide between active and passive.
For those who want to invest in these hybrid vehicles, Martin Bamford, managing director of Informed Choice, suggests: “Clients might consider replacing some exposure to index tracker funds with enhanced index investments, either Smart Beta Oeics or enhanced index ETFs.
“These might be more appropriate in market sectors where an investor would feel uncomfortable tracking the entire market, for example in European equities where there are a variety of fortunes for the different economies.”
For other advisers, the question is how best to use this in a portfolio without doubling up on exposure to certain areas, or whether it is in fact the best tool for the job.
Darius McDermott, managing director at Chelsea Financial Services, admits they would not use this type of strategy.
“We’d either pick a pure passive or a proper actively managed fund - and the latter in 95 per cent of cases. Investors tend to forget that although an index is cheap, it doesn't necessarily invest in companies you'd want in your portfolio.
“For example you could have a lot of miners or banks in which you wouldn't otherwise invest. And why would you want to invest a little more or a little less in exactly the same companies? If you find a good active manager they will have far more conviction in their ideas,” he explains.
Bryon Lake, head of Invesco PowerShares for the EMEA region, agrees that this type of “rules-based strategy means it can be a very precise tool for investors to use in their portfolios”.
He continues: “We see enhanced indexing strategies being implemented in a number of ways. Firstly, to replace the existing cap weighted exposure to help investors achieve a more specific outcome.
“Secondly, to compliment an existing holding in a portfolio by splitting an allocation with another fund. Thirdly, as a satellite investment for investors to get specific exposure in order to achieve a desired outcome.”
One of the advantages of these products is the wide variety of strategies available that theoretically can meet most investors’ needs.
Lynn Hutchinson, assistant director at Charles Stanley, points out the aim of an enhanced strategy is to track an index but attempt to outperform the index performance return by a small margin.
“An Enhanced Index (EI) may do this by over or under weighting a particular sector or individual share which the EI investment manager believes will fare better/worse.
" Another strategy is market timing - an index has a set date for rebalancing and adding or removing a share whereas an EI will make their own decision when to do this or even exclude/include a share altogether.
