Question 25 states : Are Weaver or McNally correct with their statements?
Weaver stated: an advantage of both enhanced indexing by matching primary risk factors and by minor factor risk mismatches is that there is the potential for excess return…".
My nderstanding is that enhanced by matching primary risk factors will outperform pure bond indexing because of the lwoer cost to construct, but it will still underperform the benchmark and hence have no excess return. Schweser says this statement is true, I believe its false though.
I think both have the POTENTIAL to beat the benchmark, given that both can slightly deviate risk factors (other than duration). Actually i think enhanced index has the highest IR of all strategies if i remember correctly.
page 14 in Schweser FI income book (I knew I wasnt making this up):
“Disadvantages of Enhanced Indexing by tMatching Primary Risk Factors: Lower Expected returns than the index”.
To me that sounds like no excess return…
I believe you are correct as well. The generation of alpha at almost no additional risk results in a superior IR. In the real world, I have seen quite a few enhanced index strategies generate negative alpha and have an IR inferior to that of the index they are designed to outperform.