New York - Generally, if small capitalization stocks (i.e., the Russell 2000 index) are relatively undervalued when compared to large capitalization stocks (i.e., the S&P 500 index), actively managed mutual funds may outperform the S&P 500. Of course, when large capitalization stocks are favored, the S&P 500 simply shines.
Consider the following historical points:
- The first six months of 1997 - Despite the extraordinary bull-market of that continued during the first half of 1997, this period may be considered the worst relative performance of mutual funds ever. Approximately 95% of mutual funds outperformed the S&P 500. The S&P 500 index is composed of large capitalization stocks such as General Electric and Merck which simply outperformed the market during the above period. A low-cost mutual fund that is established to mirror the performance of the S&P 500 would have outperformed most actively managed mutual funds.
- 1977 - During this time frame, almost 85% of mutual funds beat the S&P 500. During this time frame there were many small and mid-size stocks that were still undervalued after the 1973-1973 bear market. These small stocks outperformed most large capitalization stocks.
- 1994 - Between 1992 and 1993, large capitalization stocks, primarily, brand-name stocks and drug stocks had significantly underperformed the market. Brand name stocks had underperformed because Phillip Morris had announced significant price cuts to combat generic products and drug stocks had underperformed when President Bill Clinton proposed massive changes in the US health care system. Once these worries were over, large capitalization stocks came back. By June 1994, none of the top 50 equity mutual funds had beaten the S&P 500 for the year or for the three prior years.
When considering designing a portfolio of mutual funds, remember that index funds have a big advantage - lower fees. Consider that between 1986 and 1996, index funds outperformed the average mutual fund by approximately 2% points. Approximately 1% of this difference represented fees charged by actively managed funds.
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