- The Washington Times - Wednesday, February 11, 2004

Although most mutual funds saw double-digit gains last year, only 18 percent of actively managed large-cap funds outperformed the Standard & Poor’s 500 index, Wall Street’s most widely watched benchmark.

That makes for a huge number of laggards, according to the data compiled by fund research firm Lipper Inc., but it’s not surprising when you consider which stocks led 2003’s rally. The smaller, more speculative companies that shot so powerfully upward last year were off-limits for most large-cap fund managers.

So if your fund was among the 82 percent that missed the benchmark, feel free to cut the manager some slack. But you might still want to take a closer look at your strategy, and consider whether it’s worth paying a premium for active management in your core portfolio holding.

Analysts say the performance of actively managed large-cap funds is likely to improve as the market cycle starts to favor more stable, multinationals and dividend payers — instead of the risky high-flyers and troubled concerns that bounced back from the brink of bankruptcy last year.

Experts say very strong markets are challenging for money managers in general, because it’s hard to pick good positions when so many stocks are rising at once. Active managers tend to win better returns in more moderate markets, said Andrew Clark, a senior research analyst with Lipper.

“If you think this is going to be a moderate year, meaning a 10 percent return versus a 20 percent return, you may want to pay that extra money in expenses and be in active management,” Mr. Clark said.

Professional stock pickers also do well when stocks are going down, he said. But over the longer term, Mr. Clark and other analysts agree it’s no slam dunk for a manager to beat the market. Only 17 percent of actively managed large-cap funds have done it over the last 10 years, according to industry monitor Morningstar Inc.

Skilled management comes at a price, too. The higher expense ratios of actively managed funds eat into investor returns, and can even make the difference between meeting or missing a benchmark. Low expenses are often touted as one of the biggest advantages of passively managed index funds.

When you are evaluating your portfolio, you should take a close look at how much you are paying to own your funds, said Langdon Healy, an analyst with Morningstar. Keep in mind that paying more doesn’t necessarily guarantee a better product or better return.

If you are trying to decide whether to pay more for the expertise of active managers, it’s important to consider how much of an edge they are likely to gain from research. That depends largely on the area where they are invested, said John D. Markese, president of the American Association of Individual Investors. In some cases you might conclude an index fund is a better value.

“The main issue is, what can an active manager contribute? The more trodden an area is, the harder it is to stand above the others,” Mr. Markese said.

A stronger case could be made for active managers in the small-cap area, he said, where companies are less researched, or in international funds, where an analyst can ferret out little-known information and pass the advantage on to you.

One of the advantages of indexing the part of your portfolio pegged to the S&P; 500 is that its gains and losses usually run at the midpoint of the funds that use it as a benchmark, said Rich Whitney, manager of the indexed products group at T. Rowe Price.

That’s no accident, he said; fund managers watch the index closely, and will strive to be more like it. In turn, the S&P; committee that sets the composition of the index is very conscious of how actively managed mutual funds are invested, and takes that into account when considering changes.

“There’s a kind of symbiotic relationship between the managers and the index itself,” Mr. Whitney said. “When you get into other more specialized areas … you’ll find a lot more variation between what your typical actively managed fund does and what the corresponding index does.”


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