Enhanced indexing is a financial term that describes an investment philosophy that is a hybrid of active and passive management. It is a term designed to describe any type of strategy that is employed in connection with index funds whose goal is to outperform certain benchmarks. In comparison to active management, enhanced indexing will attempt to garner modest returns but will do more than other passive management techniques.
An example of this might be employed with an investor who wants to short sell badly performing stocks from an index and will then take those funds to buy shares from a company that he feels will provide him with high returns. Savvy investors can significantly outperform stocks that do not perform well by using this type of strategy.
This type of investing may seem more like passive management because investment managers are not able to veer very much from indices that are commercially available. These are indices that come from statistical bureaus such as Standard and Poor’s or The Frank Russell Company. The fees associated with enhanced indexing are lower and the turnover is lower, as well.
One might also argue that enhanced indexing is a bit like active management because it gives managers the freedom to take certain liberties with an underlying index. Doing so would keep transaction costs down in addition to reducing turnover. It is also a way to maximize tax benefits.
The strategies that you will find with enhanced indexing include enhanced cash, index construction enhancements, exclusion rules, trading enhancements, portfolio construction enhancements and tax-managed strategies.