8 Index Funds With a Leading Edge

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April 11, 2009 11:29am ETF BASIC NEWS

etf-news7Whenever the stock market takes a turn for the worse, it reignites an age-old debate in the mutual fund world: Which strategy works better, active or passive management?

Fans of active management argue that it’s well worth it to pay for the privilege of having a good manager that uses analysis to pick winning investments. However, passive investors reason the overwhelming majority of those managers inevitably underperform a given index over time. These investors simply put their cash in a low-cost index fund that tracks the returns of a benchmark like the S&P 500. The downturn just exacerbates this debate: The average S&P 500 index fund is down 4.4% in 2009, according to Lipper. Almost 40% of the large-cap funds and share classes in our database failed to beat that return. The average large-cap fund also trailed the S&P 500 in 2008. That means index funds seem to have the upper hand — at least for now.

With that in mind, we decided to focus this week’s screen on index offerings. This is a much more elaborate undertaking than it appears. We don’t simply look at S&P 500 funds since the only thing differentiating them would be the fees that eat into their performance. So instead of weeding out funds based on our regular set of criteria, this week we list a range of index funds and their performance numbers. The surprising revelation: Index funds with exposure to tech and small caps are beating their actively-managed competitors — and the S&P 500, too. See the table below for our eight picks.

There are a few reasons we resort to compiling the screen this way. Over the last few years the exchange-traded fund industry has pushed the boundaries of what constitutes an index fund. The gold standard used to be the S&P 500, but now investors can find funds based on indexes from Russell, Morningstar and Dow Jones and others that track the Nasdaq or use a new-fangled “fundamental” indexing strategy that focuses on book value and sales, among other things. There are even offerings that equal weight the S&P and concentrate on dividends.

While there may not be a huge difference between these funds’ performances, even the slightest edge can add up since index investors usually hold their funds for decades. Just 1% more a year can mean tens of thousands of dollars over the life of a retirement account.

There are certain trends worth picking up on in the index world that professional money managers and individual investors alike can follow. Technology stocks, for example, typically perform well coming out of downturns because investors rush to the few shares still experiencing growth. That theme is playing out now. The tech-heavy PowerShares QQQ (QQQQ: 32.94, +0.99, +3.09%), or Cubes, which tracks the 100 largest non-financial stocks on the Nasdaq, is up 10.9% this year thanks, in part, to merger and acquisitions and some decent earnings.

Full Story:  http://www.smartmoney.com/Investing/Mutual-Funds/8-Index-Funds-With-a-Leading-Edge/?afl=yahoo

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