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Bar charts and line charts tracking fund performance.

Enhanced Index Funds

Beginner's Guide to Enhanced Index Funds

Chris Dumont Nov 04, 2014



Be sure to read about How Index Mutual Funds Work.


Enhanced and Traditional Index Funds vs. Actively Managed Funds


Be sure to also see our Guide to the Turnover Ratio.


The Appeal of Enhanced Index Funds


  • Positioning the portfolio to a particular sector
  • Timing the market
  • Investing only in specific securities in the index
  • Avoiding certain securities in the index that are expected to underperform
  • Using leverage
  • Keeping up to date with market trends


Risks, Disadvantages, and Limitations of Enhanced Index Funds


Be sure to see the Cheapest Mutual Funds for Every Investment Objective.

Enhanced index funds typically have expense ratios between 0.5% and 1% with regular mutual funds having an expense ratio of 1.3% to 1.5%. Again, because enhanced index funds are actively managed, they typically involve higher turnover rates, costing investors in brokerage transaction fees and capital gains. Lastly, they are newer investment instruments and do not have that long of a track record to compare performance. As with any investment, some underperform, others beat their tracking index. It is up to the investor to do the due diligence required looking at the management of the fund, the expenses and turnover to see if they are better off going with an enhanced index fund over a regular index fund.


Tax Considerations


See also our 7 Essential Tax Tips for Mutual Fund investors.


Strategies


Enhanced cash managers use futures to replicate the index then they take 95% of the capital left after buying futures (which have a 20 to 1 leverage) and purchase fixed income securities.

Trading Enhancements
Short-selling or using leverage to create value through trading.

Exclusion Rules
By using certain filters, some securities are eliminated from the index to improve returns.

Tax-Managed Strategies
Tax-managed index funds manage buys and sells to minimize taxes.


Biggest Enhanced Index Funds


Intermediate-Term Bond: T. Rowe Price U.S. Bond Enhanced Index (PBDIX)

  • Total Assets: $604M
  • MER: 0.30%
  • Top Holdings: US Treasury Note 1.75%; US Treasury Note 1%; US Treasury Bond 4.375%; US Treasury Note 2%

Small Blend: Fidelity Small Cap Enhanced Index (FCPEX)

  • Total Assets: $384M
  • MER: 0.67%
  • Top Holdings: Russell 2000, Rite Aid Corp, Acuity Brands Inc., Spirit Airlines, Aspen Technology Inc.

Mid-Cap Blend: Fidelity Mid Cap Enhanced Index (FMEIX)

  • Total Assets: $360M
  • MER: 0.60%
  • Top Holdings: E-mini S&P MidCap 400 Index Future; HCA Holdings Inc.; Cigna Corp; Illumina Inc.; Cardinal Health Inc.

Large-Cap Blend: Steward Large Cap Enhanced Index Indv (SEEKX)

  • Total Assets: $214M
  • MER: 0.90%
  • Top Holdings: Apple Inc; Exxon Mobil Corporation; Berkshire Hathaway Inc Class B; Microsoft Corp; Chevron Corp

Large Value: Fidelity Large Cap Value Enhanced Index (FLVEX)

  • Total Assets: $729M
  • MER: 0.45%
  • Top Holdings: Exxon Mobil Corporation; Johnson & Johnson; General Electric; JPMorgan Chase; Wells Fargo

Foreign Large Blend: Fidelity International Enhanced Index (FIENX)

  • Total Assets: $77M
  • MER: 0.62%
  • Top Holdings: Roche Holding AG; Novartis AG; Nestle SA; BP PLC; Sanofi


The Bottom Line


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