Mutual funds that match S&P Index tend to do well

MUTUAL FUNDS

April 21, 1991|By WERNER RENBERG

When the stock market hit an all-time high last week, number of equity mutual funds hit their all-time highs, too. None did so more predictably than the handful of funds that are designed and managed to match the performance of the Standard & Poor's 500 Stock Index.

While matching the performance of the index, of course, means that a fund's shares will fall as well as peak when the market does, an S&P 500-based fund should do well over time because the market's long-term tendency is up.

The appeal of an S&P 500-based fund lies essentially in the following rationale:

* The 500 stocks included in the index account for more than 70 percent of the market value of all U.S. stocks.

* Over the years, they have had, on the average, a higher total return (price change plus dividends) than other financial assets.

* Although equity funds' portfolio managers generally try to beat the index over time, only 20 percent to 30 percent of them, on the average, manage to do so. (Unfortunately for you and all other investors seeking superior funds, it isn't always the same 20 percent to 30 percent.)

* A fund that's effectively linked to the index, therefore, should outperform 70 percent to 80 percent of all equity funds.

Performance that's in line with the index may not be good enough for those who seek maximum returns -- and who can tolerate the greater degree of risk this entails -- but it seems to satisfy a growing number of more cautious investors.

Buying stocks on the basis of the S&P 500 Index has long been regarded as a prudent approach to equity investment. It satisfied the requirement of the Employee Retirement Income Security Act of 1974 (ERISA) that pension fund assets be adequately diversified "to minimize the risk of large losses."

Not long after ERISA's enactment, the Vanguard Group extended the concept to mutual funds, offering in 1976 what is now known as the Vanguard Index Trust 500 Portfolio. For about a decade, it was the only such fund generally available to investors.

After other funds, designed exclusively for institutions or their clients, began to appear in the mid-1980s, Colonial launched its United States Equity Index Trust in 1986. The Boston Co. started a fund in 1988 but killed it after little more than a year. In early 1990, the competition for investors' money was intensified when two other large fund families, Dreyfus and Fidelity, offered their Peoples Index Fund and Spartan Market Index Fund, respectively.

But even today, with $2.8 billion in assets, the Vanguard Fund dwarfs the rest. The Fidelity fund is second with more than $100 million.

In competing with one another, the funds' managers try to see how close they can come to the index's total return. They don't expect identical performance, primarily for two reasons. First, funds incur both operating expenses and the costs of buying and selling stocks, which an unmanaged index doesn't. Second, funds may temporarily hold some cash reserves; not being fully invested in the 500 stocks in an up market can cause returns to lag.

As the table shows, results do vary. Vanguard's total return for the latest year lagged the index by 0.24 percent, essentially the same as its 0.22 percent operating expense ratio. The Fidelity Fund led the index despite a slightly higher expense ratio, temporarily capped at 0.28 percent. The portfolio manager, Jonathan Weed, attributes the edge to his ability to invest receipts from the 0.5 percent fee paid into the fund by investors redeeming shares. Fidelity imposed the fee to insulate continuing investors from costs caused by departing investors.

The Dreyfus Fund, on the other hand, lagged the index by 0.42 percent even though Dreyfus and the fund's investment manager, Wells Fargo Nikko, have temporarily absorbed all expenses and the fund has a 1 percent redemption fee, whose proceeds go to the fund. An explanation: high transaction costs, due to the fund's small size for much of the year. Colonial's return was burdened by a 1.62 percent expense ratio.

While these funds invest in essentially all 500 stocks, in proportion to their market values, other index-related funds try to excel by making different selections from among the 500. Dean Witter's invests in all 500 equally. Gateway Index Plus and Principal Preservation are invested in the top 100 stocks. Rushmore is in 80 of the largest 100. IDS Blue Chip Advantage Fund chooses from 125 to 250 of the stocks that its analysts rate the highest. Vanguard Quantitative Portfolios chooses from the 500 for at least 65 percent of its portfolio but can go beyond for the balance.

Other funds have adapted index investing to other indexes -- mostly those measuring performance of small or medium-size company stocks (NASDAQ 100, Russell 2000, and Wilshire 4500) but also those for foreign stocks, sectors (natural gas, gold) and bonds.

Whatever the funds' targets, investors seem to be increasingly interested in indexed investing. As George U. Sauter, portfolio manager of the Vanguard 500 Fund, put it, "A lot of people realize it's not bad to be average after all."

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