Which statement is true about enhanced bond indexing?

Enhanced bond indexing focuses on constructing a bond portfolio that aims to achieve a return that is above that of a benchmark index while maintaining similar risk characteristics. The approach involves selecting securities with the intent to match the primary risk factors associated with the benchmark, such as interest rate risk and credit risk, while strategically deviating from the benchmark in order to capture excess return opportunities. This means that the portfolio is designed to closely follow the index’s risk profile, which allows for an active management strategy without significant deviations that could introduce new and unwanted risks.

Matching primary risk factors ensures that the core components of the portfolio are aligned with those of the benchmark, which is essential for effective performance measurement against the index. While the strategy may allow for some selectivity in security selection, it fundamentally remains tied to the index’s overall risk structure, thereby balancing the potential for enhanced returns with an adherence to established risk parameters.

In comparison, some of the other options present characteristics that do not align with the principles of enhanced bond indexing. Enhancing returns does not necessarily equate to strictly increasing transaction costs, nor does it imply a rigid buy-and-hold approach. Additionally, while enhanced bond indexing seeks to minimize tracking error, it does not completely eliminate tracking risk, as there will always be