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Enhanced Index Funds or In Need of Enhancement?
From FundScoop Studies and Research Articles
ith most index funds in the red this year, index fund investors are turning their focus to other versions of passive investing. Enhanced index funds, which try to top the performance of a certain market index, have been in existence since as early as 1977. In the past few years, however, they proliferated exponentially as index investing made wide claims of superiority over active investing. And since the springtime sell-off, more attention has been drawn into these hyper-passive funds in hope for a better return. While there are many approaches to managing an enhanced index fund, they all typically revolve around a few basic methodologies. The most commonly used one is to own all the components of the index, then simultaneously enter into derivative contracts to try and top the returns of the index. Other tactics entail using quantitative analysis to pick some, but not all, of the index components and allocate the portfolios assets in these select few stocks.
The styles vary amongst the different funds, but they all claim to do the same thing: outperform the index they track. Predictably, the favorite index of choice is the 76-year old Standard & Poor’s 500, as it offers the broadest exposure to the markets. In fact, out of the 40 enhanced index funds in Wiesenberger’s database, 24 are S&P 500-based. Wiesenberger examined the performance of these funds over two periods. First, we compared their returns against their indices for the entire life of each fund. And in an effort to see how they held up during this year’s shake up, we inspected their returns for the period between March and November. Here is a summary of the findings for both periods, shown separately. (All performance data is as of 11/30 and assets are as of 10/31)
Results
Of the 40 Enhanced Index Funds we analyzed: -Nineteen won over the life of the fund, and 21 lost. -Of the 19 that won over the life of the fund, ten lost for the period between March and November, eight won for the same period and one fund didn't have enough history to cover that period -Of the 21 that lost over the life of the fund, 11 lost for the period between March and November, nine won for the same period, and one fund didn't have enough history to cover that period -Twelve of the 24 funds tracking S&P 500 lost and the other 12 won for the life of the fund. -One of the funds tracking the S&P 100 lost and the other won for the life of the funds. -Four of the six funds tracking small cap indexes (S&P 600 or Russell Indexes) lost for the life of the funds. -Two of the three funds tracking the mid-cap S&P 400 won for the life of the funds. -The two funds tracking fixed-income indexes (LBAB or LBGC) lost for the life of the funds. -The two funds tracking a blend index (60% S&P 500 and 40% LBAB) lost for the life of the funds.
Conclusion
As table III shows, the size, name or experience of the fund family didn’t have a big impact on the results. Gateway Fund, from the little-known Gateway fund family, trailed the S&P 500 Index over extended periods of time. American Century Investments, with over 40 years of fund management experience and almost $100 billion in assets, also saw its Equity Growth Investors Fund lag behind the index. Further, the approach by which the fund attempts to top the index doesn’t seem to be a factor in determining success either. Payden & Rygel Market Return Fund, which lost to the S&P 500, strives to beat the S&P 500 index by investing in index futures contracts, equity swap contracts and investment-grade debt securities. Conversely, Pimco Enhanced Equity Fund, which also lost to the index, tries to beat the index by using quantitative optimization techniques to construct a portfolio representative of the common stocks in the S&P 500. Two entirely different approaches, and to that end, neither could best the index.
On the flip side, the 12 funds that did beat the S&P 500 also use as many different methods as the ones that didn’t. Aetna Index Plus Large Cap Fund, for example, invests 90% of its assets in approximately 400 of the stocks in the S&P 500 index. Bear Stearns S&P 500 Stars Fund invests 85% of its assets in the index’s stocks that have a five-star rating on Standard & Poor’s proprietary stock ranking system. In the end, both funds managed to outperform the S&P 500, although using two drastically different systems. So it doesn’t seem that one particular approach yields better results than others do. Additionally, the degree of success of these funds shows no correlation to the type of index tracked, or the index’s own performance. Half of the funds tracking the large-cap S&P 500 and half of the funds tracking the small-cap S&P 600 trailed their respective indexes. The indexes’ average returns over the past seven years have been drastically different, much higher for the S&P 500 at 18.41%, versus 11.19% for the S&P 600. Yet, it wasn’t easier for the funds tracking the S&P 600 to outperform the index. Moreover, there is no evidence that the index-beaters were able to maneuver through the current market slump better than the index-laggards. Over half of the funds that won against the index over their lifetime, lost in the period between March and November.
Lastly, looking at the average age of the funds in each group, we found them to be peculiarly close. The group of 19 index-beaters had an average history of 5.45 years, while the 21 index-laggards had an average of 5.55 years. This finding completely defeats any hopes to deem longevity a factor in determining index winners. But in spite of the many inconclusive observations outlined above, there is an inference to be drawn. And as with any other mutual fund, active or passive, the caliber that makes winners is never something that you can put your fingers on so easily. The fund manager’s skills is one such intangible, which although not measurable, clearly shapes the fate of the fund. The use of leverage, especially, puts further weight on the manger’s stock picking abilities and timing. All in all, it’s a combination of many factors led by the management’s level of competence, that ultimately contribute to the enhanced index fund’s success or its demise.
About Wiesenberger
Wiesenberger, the country’s first mutual fund tracking service, has provided mutual fund data to financial professionals for more than 55 years. It is the leading provider of customized retirement, marketing and sales, and research software to both distributors and sponsors, including financial planning companies, wirehouses, broker/dealer firms, banks, mutual fund and insurance companies. Wiesenberger is a division of Thomson Financial, a US$1.2 billion provider of information services and work solutions to the financial and corporate communities worldwide. Through the widest range of products and services in the industry, Thomson Financial helps clients in more than 70 countries make better decisions, be more productive and achieve superior results. Thomson Financial is part of The Thomson Corporation, a leading e-information and solutions business with annual revenues of more than US$6 billion. The Corporation’s common shares are listed on the Toronto and London stock exchanges. For more information, visit
www.wiesenberger.com. For all your story needs, please log in to our press-only web site
www.fundscoop.com.
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