Enhanced Indexing vs passive: Same, same, but different

Our Enhanced Indexing approach is “same, same” as a passive approach, in that, similar to passive investing, it offers investors broad market exposure, liquidity, diversification, and transparency at a low cost. Where it gets “different” is in its aim. This is to outperform the market after costs, with a risk profile that is broadly in line with the market while being flexible enough to integrate sustainability preferences or client-specific customization needs.

Investors appreciate the predictability of risk and return attributes in passive solutions, as this allows them to pursue their long-term investment goals with assurance. To this end, Robeco’s Enhanced Indexing strategies have exhibited levels of volatility similar to their respective benchmarks since inception.

Because our solutions target a long-term average beta of 1 compared to their benchmarks when rebalancing, our Enhanced Indexing strategies maintain an absolute risk profile that mirrors the market, providing investors with the predictability they desire from an expected risk level standpoint.

Another reason passive investing appeals to many investors is because it offers them broad market exposure, with the resulting diversification a vital tool for managing risk. Our Enhanced Indexing strategies capture this same benefit, ensuring that our solutions offer sector and country exposures that closely mirror their respective benchmarks.

One way we can illustrate the diversification benefit in our Enhanced Indexing strategies is by examining the ‘effective N’ metric. This measure indicates how concentrated or diversified a portfolio is and represents the number of stocks in an equal-weighted portfolio that would result in the same concentration. Figure 2 below shows that our Enhanced Indexing solutions provide broadly the same level of concentration as their respective benchmarks.

While these similarities to passive are important, our proprietary approach goes beyond mere replication. Our Enhanced Indexing strategies are designed with a vital goal: delivering better returns than passive solutions, even after accounting for all costs. We achieve this through a time-tested, systematic approach that differentiates between companies with healthier fundamentals and those with weaker ones.

This process is driven by a robust stock selection model diversified across several investment styles, such as value, quality, momentum, and analyst revisions related investment themes, and augmented with novel short-term signals – and is built on over 25 years of extensive proprietary research.

The essence of our sophisticated stock selection approach is not to take large, concentrated, active positions but rather to invest in a diversified manner with a consistent preference for healthier companies. This approach has proven effective in the long run as reflected by our long-term track records.

Furthermore, alongside our smart stock selection we incorporate sustainability throughout our investment process, covering exclusions, ESG integration, SDG alignment, reducing environmental footprints, and active ownership through engagement and voting. This ensures our Enhanced Indexing strategies exhibit better sustainability profiles than their benchmarks on a holistic basis.

Investors have highly individual investment objectives, underscoring the need for obtaining tailored equity risk premium exposures that offer a more precise alignment within clients' broader portfolios. To meet this need, we have developed a proprietary customization tool that allows us to collaborate closely with clients to develop bespoke portfolios. Our Enhanced Indexing strategies can thus adapt completely to align with an investor's specific risk, return, and sustainability objectives within a mandate.

John Bogle famously advised investors not to "look for the needle, but to buy the haystack," suggesting that finding a winning active manager is difficult. However, with our Enhanced Indexing strategies, investors can, in fact, find those elusive needles — active managers that deliver on their objectives. These strategies are designed to provide such stable, long-term excess returns, but this doesn’t mean they outperform every single year.

To fully benefit from our strategies, investors need to maintain an investment horizon of at least five years. Moreover, the longer you remain invested, the lower the likelihood that your long-term returns could fall behind the benchmark. This point is clearly illustrated in Figure 3 below, which shows the annualized returns an investor would have generated over time, assuming they invested at the start of a calendar year.

Apart from two particularly challenging periods, investors who had invested in this strategy for at least three years would have enjoyed positive excess returns, illustrating the consistency and stability of the excess returns generated by our Enhanced Indexing strategies. The picture is even more favorable for the Emerging Markets Enhanced Indexing strategy, as illustrated in

Figure 4 below, as it has not experienced any extended periods of underperformance. Nevertheless, we still recommend maintaining a long-term view to maximize the potential benefits.