Passive funds have dominated inflows over the past decade, including 2014. However, active management is still favored by many investors and financial houses such as Fidelity vie for them. For investors caught in a dilemma between which to choose, Enhanced Index Funds (EIF) is the best solution.

Enhanced Index Funds, like index funds track stock market indexes, however, they mix a semi-active approach to portfolio management as there are certain modifications made to beat the return of tracking indexes. They mix the best of both passive and actively managed funds. By using enhancement strategies, including the use of leverage and derivatives, exclusion of certain securities, timing the market, Enhanced Index Funds aim to be more profitable than regular index funds.

Enhanced Index Funds versus Index Funds

Except for the "index fund" title, there are not many similarities between an Enhanced Index Fund and an Index fund. The saying “don’t judge a book by its cover” is key here, as investors may be misled by the title “index fund” in what is actually an Enhanced Index Fund.

Index funds have lower fees and lower turnover ratios. Portfolio turnover is the measure of how often a fund buys and sells assets. Index funds carry low turnover ratios. This is because buying and selling is only needed when there is a change in the underlying index. This, and the fact that there is no active management, reduces the fees or expense ratios for Index funds.

However for Enhanced Index funds, it is not only about tracking an index but also requires semi-active management. Also, as these funds do not duplicate index holdings, the turnover ratio may also be higher than Index funds. High turnover ratio also leads to higher capital tax gains.

Meanwhile, Enhanced Index Funds may offer more diversity than Index funds. Index funds may replicate an index focused on some core group, say for example value stocks or particular sectors like technology or finance.

4 Enhanced Index Funds to Buy

Markets have been volatile this year. The roller coaster ride has continued throughout this year, making it difficult for investors to make a convincing decision. The CBOE Volatility Index (VIX) proves the year’s market volatility. In January, the index gained 9.2%. This was followed by a significant 36.4% downtrend in February. Again in March, VIX jumped 14.6% but was followed by a 4.8% decline in April. So far in May, the VIX is down 16.6%.

Thus, tracking only indexes for investments may not provide a stable return now. Here, the Enhanced Index funds would be safer option.

Below we present 4 Enhance Index Funds that carry a Zacks Mutual Fund Rank #1 (Strong Buy). Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance, but the likely future success of the fund.

They have encouraging year to date, 3 and 5 year returns. These funds also carry lower expense ratio than category average.

Steward Small-Mid Cap Enhanced Index Individual (TRDFX - MF report) seeks capital growth over the long term. TRDFX aims to enhance its performance over the benchmark index by the following strategies. Firstly, it changes the relative weighting in the portfolio of growth versus value style securities in the index. Secondly, it uses quantitative analysis of valuation, growth, dividend yield, industry and other factors to balance the exclusion of certain securities owing to TRDFX’s socially responsible investment style.

TRDFX currently carries a Zacks Mutual Fund Rank #1 and has returned 6.2% year to date. The 3 and 5-year annualized returns stand at 19.7% and 16.3%, respectively. The annual expense ratio is 0.90% as compared to category average of 1.23%.

Fidelity Large Cap Growth Enhanced Index (FLGEX - MF report) invests a majority of its assets in large cap companies listed in the Russell 1000 Growth Index throughout the world. FLGEX utilizes quantitative analysis of factors such as growth prospects, valuation and profitability to select firms that may provide return, higher than the index.

Fidelity Large Cap Growth Enhanced Index currently carries a Zacks Mutual Fund Rank #1 and has returned 6.2% year to date. The 3 and 5-year annualized returns stand at 20.3% and 17.9%, respectively. The annual expense ratio is 0.45% as compared to category average of 1.19%.

SSgA Enhanced Small Cap N (SESPX - MF report) seeks to maximize total return by investing in small cap firms. These companies will not have market capitalization larger than those listed on the Russell 2000 Index. Apart from investing in common stocks and IPOs, SESPX may also invest in varied fixed-income securities and money market fund.

SSgA Enhanced Small Cap N currently carries a Zacks Mutual Fund Rank #1 and has returned 4.9% year to date. The 3 and 5-year annualized returns stand at 21.7% and 17.7%, respectively. The annual expense ratio is 0.75% as compared to category average of 1.23%.

Fidelity Large Cap Value Enhanced Index (FLVEX - MF report) seeks capital growth over the long run. FLVEX invests a lion’s share of its assets in companies included in the Russell 1000 Value Index, which consists of large cap companies. This Fidelity fund uses quantitative analysis of factors including historical valuation, growth and profitability to select companies that are believed to provide more return than the index.

Fidelity Large Cap Value Enhanced Index currently carries a Zacks Mutual Fund Rank #1 and has returned 2.3% year to date. The 3 and 5-year annualized returns stand at 21.4% and 16.6%, respectively. The annual expense ratio is 0.45% as compared to category average of 1.12%.