When An Index Fund Is Not An Index Fund

Just when I thought I had it all figured out somebody comes along with something new, or a twist on something old.  Check out Category 12-Investments, All You Need To Know.  The portfolio that you set up is 75% S&P Index Fund, 15% Small Cap Index and 15% International Index.  And you are done for at least ten years.  Simple enough.

One thing has always bothered me a little bit about the portfolio-you are buying the losers along with the winners.  Over your time horizon (20 to 40 years) that really shouldn't matter as winners become losers and losers become winners or they disappear through merger or bankruptcy. 

And they work.  The Vanguard 500 Index has beaten 60% of the actively managed domestic stock funds over the last ten years which means the index has beaten 6 out of 10 smart people with MBA's  and big offices and big salaries.  Which is why index funds usually win--they have low expenses because they don't pay big salaries or spend a lot of money on research. 

But people can't leave a good thing alone and have come up with a thing called the Sector Neutral Index Fund.  Pay attention here.  A Sector Neutral fund tracks the Sector Weightings of the S&P 500 Index but not the individual stocks.  Huh?

Ok, say the automotive section of the S&P Index is 21% made up of 7% GM, 7% Ford and 7% Daimler Chrysler.  (Bad example already as Daimler Chyrsler isn't even in the Index being a German company but you get the idea.)  So the manager of the fund puts 21% of his/her money into the automotive sector but instead of buying the GM and Ford dogs he puts all the money into Daimler Chrysler.  He still has an index (21% of his money is in automotives) but he doesn't own the stocks he thinks are going to underperform, or possibly go bankrupt.

Another example is technology.  A very volatile sector but dominated by Microsoft because of the companies large market cap.  So a manager buys the sector (20% of the Index) but doesn't buy Microsoft which means he can buy a bunch of other companies in the index or even, with some funds, buy companies not big enough to be in the index.  In the end, the manager has 20% in technology but with a lot more volatility since Microsoft isn't in the mix.  Volatility means both up and down so this is a play on whether the manager knows what he is doing.

Which gets us back to the core idea of index funds.  Buying index funds means you don't know what stocks are going up but you believe the market will go up more than other asset classes because it has for the last 100 plus years.  Picking a Sector Neutral fund means you are betting the manager is a bit smarter than the market.

In your situation I wouldn't even bother.  Stick with the regular indexes.  But if you have some extra money check out

T Rowe Price Capital Opportunity

Turner Core Growth II

Pioneer Research-A

Vanguard Growth and Income-INV

Don't know much about any of them and you will pay more in fees but the funds may have a place in your portfolio.  Maybe not now, but maybe later.