Index funds likely to ride out current lag

STAYING AHEAD

April 26, 1992|By JANE BRYANT QUINN | JANE BRYANT QUINN,Washington Post Writers Group

WASHINGTON — New York -- The most sure-fire stock market investments I know are having a bumpy ride. I'm speaking of "index" mutual funds.

For most of the 1980s, the index funds outperformed at least two-thirds of all stock-owning mutual funds that invest for growth, said Morningstar Inc. in Chicago. Last year and the first quarter of this year, though, indexed investments lagged.

They can still be fine buys, says John Rekenthaler, editor of Morningstar Mutual Funds. But for certain investments, indexing isn't the way to go.

An index fund makes no effort to pick winning stocks. Instead, it blindly buys all of the stocks that make up a certain market index, and in the same proportion. Or it buys a representative sampling of the index's stocks. The fund should then duplicate that index's performance, minus its own administrative costs.

The most popular funds copy Standard & Poor's 500-stock index. Because general market averages did so well in the 1980s even counting the two crashes), index-fund investors went home with the chips.

The non-indexed funds, or "managed" funds, hire money managers to pick stocks. For most of the 1980s, the average managed mutual fund didn't do as well as the S&P 500 or the index funds. A few turned in superior performances, but there's no way of picking them in advance. For core investments, indexing has been the way to go.

But nothing in an index guarantees that it will always outperform most money managers. Funds linked to the S&P soared in the 1980s because investors piled into the stocks that made up the S&P 500 index, the big companies and blue chips. Most managed mutual funds, by contrast, also own stocks in medium-size and smaller companies, which generally didn't do as well.

Last year, prices of smaller companies' stocks took off and carried the managed mutual funds with them. According to Morningstar, 62 percent of the growth funds outperformed the S&P in 1991, assuming dividends were reinvested. The last time that happened was 1977-1982, when as many as 88 percent of the managed growth funds beat the S&P. Those, too, were good years for the smaller stocks.

So here's how smart investors index:

* Buy pure index funds if you want to invest in large companies. Indexers almost always outperform the managed funds that invest in these stocks.

* Buy pure index funds if you're investing in high-quality corporate or municipal bonds. Their returns cluster in a narrow range. Fund managers can't add enough extra value to earn the salaries you pay them.

* Buy managed funds with good records if you're interested in smaller companies. There, the record shows that money managers have a good shot at besting comparable index funds.

* Buy well-diversified managed funds for international stocks. The international index funds generally follow Morgan Stanley Capital International's EAFE index (Europe, Australia and Far East), which may not be invested in the countries you want.

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