•
Index Funds: Unmanaged funds seek to replicate the performance of a designated index (e.g. S&P 500,
Russell 2000, Wilshire 5000)
• In 1976, Vanguard’s founder John Bogle offered to the public Index 500.
• Not actively managed; mix of securities changes only when the benchmark index changes.
•Fees and trading costs are significantly lower than the actively managed funds.
1

• Vanguard 500 has the lowest annual expense - 18 cents per $100; Morgan Stanley S&P 500 Index fund has 5.25% load and an annual expense of 69 cents!!
•Any domestic index fund running annual expenses more than 50 cents per $100 is perversion of the indexing concept.
•In 2003, $300b in asset and 323 available index funds.
• Popularity of Index funds: 80% of the fund managers (primarily equity funds) do not outperform the S&P 500 index.
2

• S&P 500 : collection of bigger companies with market capitalization ranging from $500m to $300b.
•Wilshire 5000 : collection of big and small companies - nearly 7000 stocks taded on NYSE,
AMEX, NASDAQ and other exchanges.
• Morgan Stanley EAFE index.
3

• The most common Index Funds are:
4

• Emerging Markets Index Fund: Attempts to replicate Morgan Stanley Emerging Market Free Index;
• Primarily invests in 12 developing countries, may hold shares of hundreds of firms.
• May face liquidity problem as buying and selling stocks in developing markets are difficult.
• Administrative costs, trading costs, and other fees are higher than domestic funds.
• Faces significant foreign exchange risk.
5

• Enhanced Index Fund: managed fund that attempts to beat the performance of the benchmark index by at least 0.1 but not more than 2 percent;
• If the fund performance exceeds 2 percent, the fund is considered as stock fund;
• Enhanced performance is accomplished by using variety of strategies:
• Buy all securities in the index but assign more weight to favorite stocks or sectors that are expected to outperform the index;
• May not buy all securities in the index. Buy
6

substitute securities with similar characteristics that are considered to be currently undervalued.
• May invest in options and futures
• Actively managed fund. Expenses are higher than unmanaged index funds.
• Fund performance my be affected by higher expense.
7

• Large Capitalization Index Fund: Fund seeks to track the performance of S&P 500 Index.
• Long-term Bond Index Fund: Fund seeks to represent long-term bond, 20 to 30 years,as represented by the Lehman Brothers Long-term Bond
Index.
• Small Capitalization Index fund: Tracks performance of companies with capitalization less than $1b. Benchmark is Russell 2000. When index adds/deletes stock because of their capitalization, fund sells/buys at that time and realizes capital gains.
8

• Total Market Index Fund: Fund seeks to replicate the performance of the broadest measure of the US stock market - Wilshire 5000 Index. Tracks approximately 7000 stocks.
• Also known as “Extended market” index. Most passive form of investing.
• Because the index is so broad, it is less influenced by the performance of large cap; tracks more closely the returns of small cap and mid-cap stocks.
9

• Can a market index fund or a blend of them beat the market?
•Fund of Fund: A mutual fund that invests in a group of top performing funds. Idea is appealing - the manager chooses “the best of the best” .
• Craig Isrealsen (Forbes, Feb. 3, 2003) compared Total
Index return with the return of Vanguard 500, the
Dreyfus MidCap, and the Vanguard Small cap funds.
Beginning in 1993 to now, the mix of three fund would have produced an average annual return of
9.6%, a full one percent better than the Total Index
Fund.
10

• Fund of Fund can provide instant diversification and asset allocation among different countries and asset classification.
• May incur two sets of expenses. i) expenses related to fund of fund; ii) expenses that the best performing funds will charge your fund.
• This double charges will be in the fund prospectus.
• Some fund houses are trying to avoid double charges by creating a version of fund of fund from their own funds;
• Charles Schwab is giving a new twist to fund of fund called “fund of best or top fund managers”.
Eight to
11

ten top performing investment advisers from
OneSource will pick one or two stocks that will make up a specific fund’s portfolio. Focus is to lower cost.
• Performance has varied widely mainly because of fees and expenses;
• Covariance of funds may be an issue.
12