Introduction
An active index fund is an asset basket where the fund manager builds the initial investment with assets from a benchmark index and either adds unrelated securities to the underlying index or eliminates existing index components intending to achieve higher portfolio results.
This additional non-benchmark securities layer aims at raising returns above a conventional buying and keeping a passive strategy by enabling some active management.
By adding separate stocks that are disconnected from the broader index, the fund manager can unlock further alpha. Active index funds may use tilt or a smart beta approach.
Understanding Active Index Fund
An active index fund aims to take an index fund version, such as the Standard & Poor's 500 Index (S&P 500), and regularly rebalances all securities to suit the proportions found in the real S&P 500. The manager will add stocks to the fund that they believe the passive index fund will yield additional returns.
For example, if the manager assumes that semiconductors would deliver excellent results for future quarters, there will be more stocks of semiconductors added to the portfolio. Although some fund managers can dramatically beat the underlying benchmark index with the use of techniques, such as market timing, this is far from assured.
Limitations
Although an active index fund holds many of the same securities held by a traditional index fund, they tend to come at a prime. Taking an active style of management ensures that the fund would have to charge higher fees to cover the manager's expenses, analysis materials, and all other data needed to make informed investment decisions.
Such higher investment ratios are placing pressure on fund managers to outperform or exceed the index consistently. As in a mutual fund, the investor has the potential to achieve outperformance. Many have a knack to find hidden gems, but most are going to pick losing assets that restrict the fund's potential output.
