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New Enhanced Index fund: a global equity fund with tax benefits

New Enhanced Index fund: a global equity fund with tax benefits

13-12-2016 | Research

Robeco has introduced a new version of the Enhanced Indexing fund for developed markets, which has been tax-optimized for Dutch retail investors. Enhanced Indexing, which has an excellent 12-year track record of over 1% outperformance per year at a tracking error of around 1%, offers a credible alternative to passive investing.

  • Machiel Zwanenburg
    Machiel
    Zwanenburg
    Portfolio Manager Quantitative Equities
  • Wilma de Groot
    Wilma
    de Groot
    CFA, Director, Portfolio Manager
  • Michael Strating
    Michael
    Strating
    Managing Director Quantitative Equity

Speed read

  • Global Enhanced Index fund is Robeco’s alternative to passive
  • Based on global equity strategy with excellent 12-year track record
  • Fiscally optimized structure for Dutch retail investors

The new Robeco QI Global Developed Enhanced Index Equities Fund has been specifically launched for Dutch retail investors, who can now invest in Robeco’s Developed Enhanced Indexing strategy.

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The advantages of passive investing, without the drawbacks

The fund is an attractive alternative to passive. Passive investing is an appealing concept as it offers liquid exposure to the equity market premium with predictable risk-return characteristics and portfolio holdings at relatively low fees.

However, passive investments also have several disadvantages:

  • Pure passive investment vehicles always lag the index from a net of fee return perspective.
  • They do not integrate over fifty years of proven academic insights to build portfolios.
  • Advanced sustainability integration is hardly available.

Robeco QI Global Developed Enhanced Index Equities Fund has all the advantages of passive investing and, moreover, is designed to address these concerns.

Why ‘enhanced’?

Passive vehicles replicate an index by obtaining exposure to all index constituents. The weights of the index constituents resemble the exact weights in the parent index. Our Enhanced Indexing strategies enhance an index by gaining exposure to the largest index constituents and adjusting their weights depending on their attractiveness. Attractive stocks receive a higher weighting, unattractive stocks a lower weighting. These deviations from the index weights are relatively small, around 20 basis points.

The relative attractiveness of stocks in global developed markets is determined by a quantitative stock selection strategy, which results in a well-diversified portfolio (ca. 700 stocks) with a low tracking error against the MSCI World index. The strategy aims to maximize the excess return versus the index within risk constraints and is based on the same proprietary stock selection model and portfolio algorithm that have been used successfully in the Robeco Quant Developed Markets Equities Fund since 2004. Index changes are effectively implemented.

The fund has a fiscally optimized structure for Dutch retail investors to prevent double taxation of dividends. Compared with most passive funds that replicate the MSCI World Index, the tax advantage amounts to approximately 0.43% per year.

The investment strategy: proven factors and sustainability integration

Although passive investing has some very appealing concepts, the prospect of continuously lagging the index from a net of fee return perspective is not appealing. Although the academic community is inconclusive on the net added value of mutual funds collectively, many studies have shown that portfolios based on particular characteristics, such as attractive valuation and high momentum, outperform portfolios with opposite characteristics.

At Robeco we have been analyzing proven factors such as value and momentum since the early 1990s in developed markets. We have managed enhanced indexing strategies for developed markets since 2002. Our enhanced indexing strategies use an integrated combination of value, quality and momentum factors and a transparent portfolio construction algorithm, designed to consistently outperform an index and maximize the information ratio. The enhanced indexing strategy in developed markets has an information ratio of more than one since inception.

In addition to the well-known quantitative factors, sustainability integration is also becoming increasingly important for investors. We notice that sustainability integration often goes beyond negative screening by excluding a group of ‘non-sustainable’ companies, and rather focuses on, for example, giving more weight to sustainable companies. Positive sustainability screening requires an active approach.

In our Enhanced Indexing strategies, companies with a favorable ESG score have a higher chance of ending up in the portfolios as we ensure that the portfolio’s weighted ESG score is at least as strong as that of the index.

Robeco QI Global Developed Enhanced Index Equities Fund pursues the exact same strategy as the institutional Robeco Quant Developed Markets Equities Fund, whose track record is shown in Figure 1.

Figure 1 | Track record Robeco Quant Developed Markets Equities strategy

Source: Robeco. Composite Quant Developed Markets Equities, gross of fees, based on net asset value, figures in EUR, inception date November 2004, tracking error limit 2.0%. The value of your investments may fluctuate. Results obtained in the past are no guarantee for the future.

Tax advantage: preventing double taxation for Dutch retail investors

Dutch private investors can prevent double taxation of dividends by investing in a special fund vehicle (an FBI or ‘Fiscale Beleggingsinstelling’). In such a fund, proceeds are already subject to tax. The tax treaty between the US and the Netherlands reduces the 30% US withholding tax to the 15% treaty tax rate. The remaining 15% is taken into account as a tax credit at fund level. If the Enhanced Indexing strategy were to be offered as a Luxembourg vehicle, Dutch investors would have to pay the full 30% US tax. The FBI structure offers them an additional return of approximately 0.43% at a total portfolio level.

Figure 2 | The tax advantage explained

Source: Robeco. Results shown are the results for Robeco Global Developed Enhanced Indexing as measured by the Composite Quant Developed Markets Equities, net of 30 bp management fee, based on net asset value, figures in EUR, inception November 2004. We assume 20 bp management fee for the ETF. Measurement period: November 2004 – October 2016. Results obtained in the past are no guarantee for the future.

The new Robeco QI Global Developed Enhanced Index Equities Fund is very suitable for creating a strategic or tactical allocation to global equities in any portfolio. This can easily be adjusted as the fund invests in highly liquid securities only.