Enhanced – index-based management with the possibility of excess return
An index fund aims to track a reference index as closely as possible, while a traditionally actively managed fund can deviate more significantly from the reference index. Enhanced management combines an index-like portfolio with limited, targeted deviations that allow for excess returns.
Deviations from the index are kept within defined limits for active risk. This is measured by tracking error, which describes how closely the fund follows the reference index. The lower the tracking error, the closer the fund follows the reference index.
The goal is that many small contributions combined will provide higher returns than the reference index over time. However, excess returns are not guaranteed, and the funds may also yield lower returns than the index.
DNB's Enhanced management is based on four main sources of potential excess return: index rebalancing, capital market transactions, corporate events, and relative value.
1. Index Rebalancing
Index providers regularly update which companies are included in an index and their respective weights. Traditional index funds typically adjust their portfolios as the index provider rebalances the index. This means that the index fund buys companies entering the benchmark index and sells those that are leaving the benchmark index.
Enhanced funds can position themselves in a company before, during, or after an index change to capitalize on price movements related to expected buying and selling. This can reduce trading costs or provide more favorable prices, but it can also result in losses if prices move differently than expected.
2. Capital Market Transactions – ECM
Capital market transactions in the equity market, also known as ECM (Equity Capital Markets), include IPOs, issuances, and larger sell-offs. Funds may participate when the price is deemed attractive compared to similar companies or the market overall. Traditional index funds have less flexibility to exploit such transactions, as they must adhere to the composition and weighting of the benchmark index. .
Attractive pricing of such transactions may be due to the size of the transaction, the seller's desire for a secure execution, or that investors are compensated for short-term uncertainty.
Funds are not guaranteed allocation. Any discount is also no guarantee of positive returns.
3. Corporate Events
Acquisitions, mergers, demergers, buybacks, and capital distributions can create temporary price discrepancies and investment opportunities that are not necessarily exploited in an index strategy.
The Enhanced team evaluates terms, likelihood of execution, timelines, and alternative investments before adjusting exposure within the fund's risk parameters. The outcome is uncertain, and positions can contribute both positively and negatively to returns.
4. Relative Value
Investments with equal or nearly equal exposure can be priced differently. This can apply, for example, to different share classes in the same company or companies with similar characteristics and market drivers.
Enhanced management can increase the weight in investments considered relatively cheap and decrease the weight in those considered relatively expensive.
The goal is to exploit relative price differences rather than to take a clear stance on the market's direction. However, price differences may persist or increase.
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