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According to a piece (subscription required) in The Wall Street Journal, enhanced index funds are lagging the market.

These funds seek to combine active investing with indexing, and often attempt to enhance performance through derivatives trading, or weeding out stocks that the manager believes are particularly bad. The goal is to attempt to outperform the index by 1 or 2 percentage points with limited volatility.

This quote from The Journal pretty much sums up the problem:

"Typically, enhanced index funds have very reliable higher returns than the benchmark index they track," said Carl Hess, practice director for the Americas at Watson Wyatt Investment Consulting.

But like the old efficient markets analogy about walking around in a parking lot looking for dollar bills, any investment that provides "very reliable higher returns" is destined to level off once its superiority becomes common knowledge. The whole basis for indexing is the acceptance that beating the market is close to impossible, and that the only things we as investors can really control are fees and diversification. The idea of enhanced index funds is a bit of a contradiction.

Investors should probably stay away from these funds, particularly those with high fees. If you want to try to achieve returns close to those of the indices, your best bet is traditional index funds.

Enhanced index funds struggling: a sign of things to come? originally appeared on BloggingStocks on Thu, 13 Sep 2007 17:02:00 EST. Please see our terms for use of feeds.

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