clock menu more-arrow no yes

Filed under:

WORLD OF INDEX INVESTING IS SHEDDING PASSIVE IMAGE

For all its billing as a "passive" way to manage money, the world of index investing is teeming with activity right now.

Index funds, set up to duplicate the performance of an index of stock prices, boomed in the 1980s as increasing numbers of pension funds and other large pools of money embraced the idea.By some estimates, the amount of capital committed to index investing quintupled during the decade, to $250 billion.

So far in the early '90s, financial advisers and institutional managers have been scrambling to stay on top of this trend and figure out where it may lead next.

The latest case in point: the debut last week of Standard & Poor's Corp.'s index of medium-sized, or "mid-capitalization," stocks, which have been widely touted as the next prime target of index-fund managers.

In the stock market's rally since last fall, shares of small to medium-sized companies have handily outperformed the big-name blue chips.

Analysts like Jack Lavery, global research director at Merrill Lynch, predict a continuation of this trend as the economy begins to pull out of the recession.

"The launch of the new S&P mid-capitalization index should reinforce investor interest in this sector," Lavery maintains.

Many observers see more than a little irony in all this - a rush to try to outthink an idea that was explicitly created as a "no-brain" way to invest.

Modern index investing grew out of academic research focusing on the premise that professional money managers as a group could never beat the market, since they effectively were the market.

Because they spent a lot of money on things like research and trading, their aggregate results would naturally tend to come in below those of an index like S&P's 500-stock composite, which was encumbered by no expenses.

In other words, an index fund designed to match the makeup of the 500 while minimizing operating costs could reliably be expected to produce results well up in the top half of money managers' performance rankings.

To add yet another ironic twist, indexing, founded on the assumption that the stock market was highly "efficient," thrived in the '80s with the help of an apparent inefficiency - namely, a stronger showing by the big stocks that made up most indexes than by the rank and file of smaller issues.

Why did the big stocks do better? In part, most analysts agree, because of the very fact that so much money was pouring into index funds, creating extra demand for the stocks that dominated the indexes.

If the '90s reverse this pattern, favoring small stocks over big ones, observers see a variety of intriguing prospects.