Bea Associates: Enhanced Equity Index Funds
Posted: 25 Jan 2000
Date Written: Rev. 1994
SUBJECT AREAS: equity index funds, total return swaps, index-linked notes, index futures, implementation costs (transaction costs, custody fees, withholding taxes), portable alpha. CASE SETTING: 1992, U.S.
BEA's enhanced index fund product uses derivatives and cash market securities to find the most efficient way to track an index. The considerations involve transaction costs, custodial fees, withholding taxes on dividends, and fees from securities lending. In the case, BEA is faced with the task of investing an off-shore portfolio so as to track the S&P 500. The choices for obtaining exposure to the S&P 500 include buying the underlying stocks, buying an S&P 500-index-linked note, buying futures, and entering into an S&P 500 swap. Evaluation of the S&P 500 futures and swap alternatives also requires analysis of several short-term fixed-income alternatives.
The case is a vehicle for discussing the use of derivatives in the implementation of investment decisions, with particular emphasis on the comparative advantage enjoyed by certain investors by virtue of their tax status or country of residence, and the costs associated with investing in various instruments. The case can also be used to discuss the role of intermediaries in performing custom contracting for investors, and the use of derivative instruments to transfer excess returns ("alpha") from one asset class to another.
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