Combining the advantages of active and passive
Enhanced indexing seeks to outperform a benchmark while maintaining portfolio characteristics that remain broadly similar to the index. It combines active stock selection with disciplined risk management.
Our Research Enhanced Index (REI) mutual fund and exchange-traded fund (ETF) strategies blend active stock selection with index-like profile in a robust investment framework, seeking positive alpha with low tracking error. They can complement passive core equity allocation, and add diversification while seeking incremental returns above the benchmark.
Most enhanced managers use a quant approach to enhanced indexing, but our REI approach is built on global fundamental research. By combining bottom-up fundamental stock selection with index-like portfolio characteristics, we aim to uncover compelling opportunities and deliver strong risk-adjusted returns over a full market cycle.
A common trait of enhanced indexing strategies is that they tend to have more efficient risk management, (i.e. higher information ratios), than traditional active strategies.
Why does the information ratio matter?
Information ratio (IR) measures excess return relative to tracking error, that is, it compares a strategy’s return above its benchmark to how much its performance differs from the benchmark. A higher IR indicates that a manager can generate more benchmark-relative return for each unit of active risk taken. Historically, managers who produce high IRs have a higher probability of outperforming the benchmark over any time period.
While IR does not guarantee future success, it presents a useful way to judge how consistently and efficiently a manager has outperformed or trailed the benchmark.
What can support a strong IR?
The Fundamental Law of Active Management3 presents a useful framework for understanding the potential drivers of IR. In its extended form, expected IR depends on three elements:
1. Skill: the relationship between forecast returns and subsequent outcomes.
2. Breadth: the number of sufficiently independent investment decisions.
3. Implementation: how efficiently the manager can translate insights into the portfolio, given real‑world constraints.
The framework suggests that a manager does not need perfect forecasting skill to add value. Modest skill applied consistently across a broad set of sufficiently independent decisions may support a stronger IR, particularly when the portfolio can translate those insights efficiently after allowing for constraints, transaction costs and risk controls.
How our REI approach applies these principles
While many enhanced-indexing strategies rely primarily on quantitative signals to generate alpha, our REI approach is founded on bottom-up fundamental research.
We believe the combination of global research insights and disciplined portfolio construction brings together the three key drivers of The Fundamental Law of Active Management: skill, breadth and implementation.
- Skill: Our global research team of approximately 80 investment professionals combines deep sector expertise with decades of investment experience. Using a consistent long-term valuation framework, analysts seek to identify companies with attractive expected returns.
- Breadth: Our research platform covers more than 2,500 companies globally, providing a broad and diverse set of stock-specific insights.
- Implementation: Our portfolio construction process seeks to efficiently translate these insights into a diversified, benchmark-aware portfolio. By maintaining relatively low tracking error and controlling unintended regional, sector and style exposures, active risk remains focused on stock selection.
While this approach has proven durable over time, we consistently review, evaluate, and invest in advancing our research process. We continue to refine our methodology to align more closely with our core beliefs and fundamental convictions, especially as the investment environment evolves.
Conclusion
REI brings together fundamental stock research and disciplined portfolio construction. By applying stock-specific insights across a broad investment universe while maintaining index-like characteristics, the approach seeks to generate incremental returns without taking the level of active risk commonly associated with more concentrated strategies.
Our approach is supported by a global research platform, a consistent valuation framework and ongoing investment in people and technology. Together, these capabilities provide a repeatable foundation for seeking long-term excess returns.