On the average, it's hard to beat the index funds

ANDREW LECKEY

March 05, 1993|By Andrew Leckey | Andrew Leckey,Tribune Media Services

Sometimes average is beautiful.

Index funds, which try to duplicate the performance of a given set of stocks such as the Standard & Poor's 500, appeal to investors who simply want the market's average.

This "no-brainer" approach is gaining in appeal.

Over the past decade, the Vanguard Index Trust 500 Portfolio turned in an average annual return of 15.5 percent, compared with the average growth and income fund's return of 12.90 percent.

That's not to say some of the better growth funds didn't do even better, especially when the market was hot, but index funds never do much worse than average either.

Spurred by this realization, assets of index mutual funds ballooned to $19 billion from $1.5 billion five years ago. More than 60 index funds now replicate a number of indexes through

calculated samplings of large, small or international companies. Newer specialized index funds target groups such as gold-mining, value and growth stocks.

The cost structure is one reason for these funds' attractiveness.

"In an active mutual fund, you can turn over 50 to 100 percent of the portfolio in a year and get eaten alive by transaction costs, while average turnover in an index fund is only 2.5 to 3 percent," explained Albert Neubert, director of index products and services for Standard & Poor's Corp. "In many cases, index funds are 'no-load' [no initial sales charge] and have minimal annual costs of less than 1 percent."

Vanguard Group, whose Index Trust 500 is the oldest and largest fund, points out that management costs cause fund returns to deviate from that of the underlying index.

"Our competitors lose money offering index funds and have them only because customers demand them, but the low-cost Vanguard not-for-profit corporate structure suits them perfectly," said George Sauter, portfolio manager of Vanguard's five index funds. "We don't need a profit margin."

Top Standard & Poor's 500 composite stock price index funds over the last 12 months (when the return of the actual index was 10.57 percent), according to Morningstar Mutual Funds, were:

Peoples Index Fund, Dreyfus Corp., Providence, R.I., $98 million in assets, $2,500 minimum, up 10.49 percent; Vanguard Index Trust 500 Portfolio, Valley Forge, Pa., $8.6 billion in assets, $3,000 minimum, up 10.37 percent; and Fidelity Market Index Fund, Boston, $300 million in assets, $2,500 minimum, up 10.19 percent.

"An index fund is basically unmanaged, so while you don't have anyone who can mess it up, you also give up potential to 'shoot out the lights' in outperforming the market," said Jonathan Weed, portfolio manager of the Fidelity Market Index Fund. "There are a few index funds out there that are in the top tier of tracking their index, and the one I manage is one of them."

Among the best-performing funds that track various small company indexes over the last 12 months were:

Vanguard Small Capitalization Stock Fund (investing in a sampling of 400 stocks on the Russell 2000 Index, which was up 13.24 percent), Valley Forge, Pa., $302 million in assets, $3,000 minimum, up 13.62 percent; and Peoples S&P MidCap Index Fund (investing in stocks from the S&P MidCap 400, which was up 11.41 percent), Dreyfus Corp., Providence, R.I., $49 million in assets, $2,500 minimum, up 11.30 percent.

"A drawback of an index fund is that you're buying both the stock market's winners and losers, while the better portfolio managers of other funds are able to increase their portfolio's value in certain markets," said John Rekenthaler, editor of the Morningstar Mutual Funds investment advisory publications.

"Biggest benefit of an index fund is that you're given the chance to invest in hundreds of stocks without being crucified by commissions."

But when a region or stock segment is down, so is the index fund that attempts to replicate it. International investing is an example of recent weak results.

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