| BUSINESSWEEK ONLINE : FEBRUARY 22, 1999 ISSUE | ||||||||
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| COVER STORY
The Debate Goes On: Use Brains or Indexes? Byron R. Wien, U.S. equity strategist at Morgan Stanley Dean Witter, and John C. Bogle, senior chairman and founder of Vanguard Group, are good friends. But the Wall Street veteran and the index-fund pioneer differ on the merits of investing in funds that replicate broad measures of market performance. The two have debated the issue since Wien wrote an essay, ''I Hear the Death Rattle of Indexing,'' in 1993. With indexing anything but dead, they turned to Personal Finance Editor Anne Tergesen to chronicle the latest installment of their argument. Will active managers have their day? BOGLE: If we get a big recovery in small stocks, it is possible, and I would even say likely, that the average mutual fund will begin to outperform [the Standard & Poor's 500-stock index].... People are investing very heavily in the S&P 500 because they are always looking for the hot fund. But where index funds find their finest fruition is in the total stock market [the Wilshire 5000 index]. That is the theory of indexing: Own the market and by the time we take out our tiny costs, you will beat most participants. WIEN: Like any other strategy that works, indexing has a susceptibility to get overdone. When that happens, it will underperform for a period. This market tends to recognize what's working well and investors flood into it, ignoring the wallflowers. Right now, the top 50 stocks in the S&P 500 have an average price-earnings multiple of 47 on forward earnings and the other 450 have a p-e of 20....If the 50 most dominant stocks that are driving the index slow down and the bottom 450 start to outperform, chances are the active managers will start to outperform. That's because they own a disproportionately smaller share of the dominant stocks and a disproportionately larger share of rest. Does indexing work for smaller stocks? BOGLE: Small-cap indexing works better than large-cap indexing, in part because [managed] small-cap funds are a lot more expensive to run. Also, small-cap stock funds take on about 35% more risk than the [Russell 2000] index. Therefore, on a risk-adjusted basis, small-cap index funds do 4.4% better than active managers. WIEN: It's hard to find a good small-cap index that's representative of the asset class. International indexes very often have more serious problems. In some countries, you can have a single stock that represents 30% of the market. Very few people would be willing to put that much of their assets in one company. Are index funds the wave of the future? BOGLE: Five years ago, I said the Vanguard 500 Index Fund would be the largest fund in America by the end of the millennium. I don't have any trouble thinking that will come true. WIEN: Investment management is a rare skill, refined over time. Some money managers, over longer periods, have beaten the market by quite a lot. There's no guarantee they will do it in the future, but that's the way to bet. _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP |
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