Allure of indexing grows as big companies slump


February 28, 1993|By Thomas Watterson | Thomas Watterson,Boston Globe

For investors discouraged by the troubles of big companies such as IBM, Sears and General Motors, it may be time to stop chasing stocks or looking for stock pickers. For them, indexing, one of the best investment ideas of the 1980s, could also be one of the best ideas of the 1990s -- as long as they make a few modifications.

More than $10 billion has been poured into index funds in the past dozen years or so, as investors decided it was too much trouble trying to find a fund manager who could "beat the market."

Because about three-quarters of all mutual funds don't beat the market, these investors are happy to do as well as the market, as long as their money keeps growing.

With indexing, the manager of a mutual fund creates a portfolio with a performance that closely matches the target index.

Some examples: the Standard & Poor's 500 index of the biggest-company stocks, the Russell 2000 index of small-company stocks, an index of Pacific Basin stocks, or even the stocks of companies in one region, such as the Northwest.

In the 1980s, the best-performing index was the Standard & Poor's 500, as big-company stocks surged. Now, though, small-company stocks seem to be outperforming the S&P, so some people argue that indexing doesn't work any more.

"Index funds' 1980s success owed as much to the S&P 500's victory as to their popular merits," John Rekenthaler, editor of Morningstar Mutual Funds, wrote in the newsletter last year.

His argument got some support when Pensions & Investments magazine reported that pension funds, which have more than $367 billion invested in index funds, lost 1 percent of their money, or about $3.67 billion, since July just from the collapse of IBM's stock.

However, says James Pinney, a financial planner with Pinney & Scofield in Cambridge, Mass., there is more than one index, and investors who only use the S&P 500 are assuming more risk than they are probably prepared for.

"The S&P 500 is one of the worst-performing indexes over the long term," Pinney argues. "A strategy of portfolio allocation across a spectrum of other indexes will, in time, do better than the market."

The leader in the indexing business is the Vanguard Group, in Valley Forge, Pa. ([800] 662-7447), with several index funds, covering large-company stocks, small-company stocks,European stocks, Pacific Basin stocks and a total stock market index covering both large- and small-company stocks in the United States.

Other companies, including the Dreyfus Funds in New York ([800] 645-6561) and Fidelity Investments in Boston ([800] 544-8888), also offer index funds. In Fidelity's case, however, the Market Index Fund, which tracks the S&P 500, looks like a bit of an outsider in a company that emphasizes the stock-picking skills of its fund managers.

"We've always considered ourselves a full-service investment firm," says Roger Servison, president of Fidelity Retail Marketing Co. "There has been a demand for index funds, so we offered one."

Even Rekenthaler, who wrote somewhat disparagingly of indexing earlier, now says: "I'm not going to knock indexing. There's a lot of logic to it."

For example, he says, if an investor insists on funds with managers who actively manage their portfolios, two scenarios have to work out properly:

First, the manager has to be able to find a combination of stocks that will consistently outperform the market. Second, the investor has to find those top managers among the thousands who are handling mutual funds. Then, if a good manager leaves or retires from the fund, the investor has to find another one.

With an index fund, Mr. Pinney says, you'll almost never have the best-performing fund.

On the other hand, over a period of 10 years or more, your fund will always be in the top 20 percent or 25 percent.

Considering how many "top-performing" funds end up in the bottom third or quarter of their group just a few years later, that's not an insignificant consideration.

However, Mr. Pinney agrees that people who concentrate on the 500 may be disappointed in the near term.

Therefore, he recommends a portfolio that includes Treasury bills, bonds and a mix of indexes, covering large and small stocks in the United States, Britain and Japan, as well as large-cap value stocks and small-cap value stocks.

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