The results for 1976 are just beginning to come in, but it appears that forget another year the broad-based Stanfard & Poor's market index of 500 stocks - the S&P 500 - will have out-perimned most institutional stock portfolio managers.
The portfolio manangers are the investment professionals who eillectively control more than $100 billion in equity assets for thousands of persion, trust, endowment and nurmal fuids.
They trade in and out of the market daily, investing the inflow of new funds and juggling their other holdings, routinely buying and selling duge blocks of stock, digesting fat investment research reports, all with the purpose of earning as much as possible for their clients and collecting a handsome annual fee of several per cent of the managed asses along the way.
But according to the latest Becker Securities Corp. annual study - believed to be the largest of its kind with 4,000 funds and $30 billion in story assets in the sample - only 13 per cent of the institutional fund managers did better than the S&P 501 "average" in 1976, while 77 per cent did worse. The S&P 500 went up 23.7 per cent last year, including dividend renvestment.)
For the last 10 years, the trend is even more underwheming, with about 90 per cent of the bank trust accounts, employee pensim funds and other institutional portfolios underperforming the S&P index, and may 10 per cent above it for the decade.
And it is estimated that only 2 per cent of the funds manager to consistently do better than the S&P 500 for this entire period.
While the latest news from the Becker Securities Fund Evaluation Service must be acutely dispirting to the hard-working investment professionals, it is giving a solid boost to the advocates of "indexing" like the Wells Fargo Bank here, which pioneered the concept five years ago as the best longrange strategy for playing the market.
"These funds, which had only a few million dollars just a few years back, are now somewhere in the area of $2 billion in size," says William L. Fouse, vice president and deputy manager of the bank's investments advisers unit which manages approximately $580 million in indexed funds out of total equity assets of $1.4 billion. And Fouse says "the bulk of new money coming in is index money."
"I wouldn't be surprised to see a 50 per cent growth on top of the existing base this year, and that may understate the opportunity," he adds. "I think certainly we - and to our knowledge, the other purveyours - have been exceptionally busy in talking to corporate officials interested in pursuing this strategy, and I would expect substantial growth over the next 5 to 10 years. "When the performance results become available for 1976 as a whole, they will show again the difficulty for a typical fund manager of keeping up with the index," he predicts.
Indexing means matching the makeup of the portfolio you manage with the proportionate weighting of some broad stock index - most popularly the S&P 500, which accounts for 85 per cent, or $600 billion, of the capitalization of New York Stock Exchangelisted companies - so you at least can duplicate the performance of the index. An S&P 500 index fund, for example, would have 6 per cent of its assets in IBM at the high end and 0.001 per cent in Sonesta International on the low end, with the other stocks falling in between according to their weighting.
The reason why the active managers inherently can't and don't do better as a group than the index is the idea of "market efficiency," according to Fouse and other theorists. That means the price of any particular stock very quickly and "efficiently" reflects all publicly available information about a company, making it difficult for anyone, including professionals, to get much of a trading edge.
After subtracting for in-and-out trading and management costs, and for the volatility of less-diversified portfolios, several percentage points are lopped off the net average expected performance, making it hard for the active manager to end up even with the market since he must outperform it along the way.
So the theory goes, and it certainly is borne out by the statistics which show that in recent years the funds as a group dropped faster on the downside and lagged behind on the market's move up as well.
The very low turnover required on an indexed portfolio means management expenses are about one-tenth of the costs on an actively managed portfolio, Fouse estimates.
Also known as "passive management," indexing seems to be the fund manager's equivalent to throwing his hands into the air helplessly. And it has drawn vigorous and emotional criticism from many of the investment pros whose pride and livelihood are both on the line.
Indexing, it is charged, is everything from lazy to excessively cautious and even vaguely un-American in its seeming ethics of giving up.
"It's like all the baseball teams at the beginning of the season agreeing in advance to win half the games and lose the other half," says Leon G. Cooperman, head of investment strategy at Goldman, Sachs & Co.
"Not many industries in America have a popular new product that promises mediocrity," complains David H. Williams, executive vice president of Mitchells, the institutional and research-oriented brokerage firm that was a major proponent of the now-tarnished gross stock concept that led to concentrated protfolios of so-called "nifty fifty" stocks.
Harrison Smith, executive vice president of Morgan Guaranty Bank's trust department - the largest in the country with more than $20 billion in assets managed - argues that the volatility of the market in the last four years is the reason that his bank and other prestigious that his bank and other prestigious institutional fund managers have been bested by the index. But he predicts that there again will be periods when he and the other portfolio pros consistently will do better as a group, provided thr market calms down.
"We believe that this period we have gone through was an unusual one because of the extreme violence of the bear market," says Smith. "In our case, we have a long history beginning in 1960 of very fairly consistently beating the averages in equity accounts, not every year, but the periods we did not do so were relatively short until the 1973-76 period."
THe statistical comparisons going back to less volatile market periods, however, also show the lion's share of fund manager doing worse than the index over the long haul.
And despite the criticisms of indexing, the statistics seem to be convincing a number of clients frustrated by the consistenly sub-par performance of their portfolios. And they are in turn pushing reluctant managers to offer indexed services.
The Stanford Research Institute, in a recently concluded one-year study on trends in investment through the early 1980s, concluded that passive portfolio management some day could account for 30 to 50 per cent of the institutionally held funds.
A growing number of big bank trust departments, despite misgivings, are offering index investment services because of client pressure. New York's Manufacturers Hanover Bank, for example, publicly denounced the trend but recently initiated service. And many other banks and insurance companies indicate they are studying it.
There is an indexed mutual fund for individual investors called the First Index Investment Trust, and there are likely to be more.
The Exxon Corp. recently switched another $10 million from its employee pension fund, which it manages inhouse, to an indexed format on top of $100 million already there. AT&T's nien Bell System companies have about $400 million in indexed investments out of a $16 billion total, and officials of the company have indicated they may switch considerably more.
The current total of $2 billion in indexed funds is more than double what it was a year ago at this time, and the flow appears to be quickening, with some putting the possible total by the end of 1977 at $10 billion.
Even the market's recent slump - which has been most pronounced in the glamor and blue-chip sectors that were weighted heavily in institutional portfolios - is being blamed in part on the indexing wave.
Ed Bunce, who heads the $5 billion equity investments division of the Prudential Insurance Co., believes indexing "is probably one of the reasons why some of the high-multiple and heavily capitalized stocks have been under pressure for the last few weeks. You've obviously got to sell some things to buy other thing" in order to match the holdings of the S&P index, he says.
Like other skepticl fund managers, Bunce sees some trading opportunities created by the trend which, it is argued, works to produce market inefficiencies by focusing on a select, albeit large, group of stocks to the exclusion of others.
"You might buy the stocks that you think the indexers are going to have to buy, and sell short the over-weighted holdings," says Bunce as one possible strategy.
Cooperman of Godman Sachs says, "Nineteen seventy-seven's answer to the index funds will be the companies outside the index." He adds that "if the opportunity to underperform existed for the last 10 years, the opportunity to outperform exists for the next 10 years."
Wells Fargo's Fouse neither believes the indexing trend has added to the market slump - noting that the $2 billion in total indexed funds is relatively small, nor that indexing can distort the market in the first place by creating inefficiencies.
"We don't see any relative stock price implications of membership or non-membership in the S&P 500," says Fouse, calling the idea that trading oportunities exist in the stocks that are not on the index "utter nonsense."
"The most efficient protfolio is the index fund because by definition it is the market," says Fouse. There is nothing particularly sacred about the S&P 500, he concedes, and says that in the future there could be a Wells Fargo 600 or 800 that is similarly broad-based and could include international stocks as well.
The bank includes only 495 of the S&P 500 stocks on its list right now. Five companies are excluded because of financial difficulties that could get one of them into trouble. And to fulfill its fiduciary duty, Wells Fargo monitors the list for other companies that in the future could run into difficulties similar to Penn Central or W.T. Grant, which went bankrupt while they were on the S&P list.
Wells Fargo does not recommend indexing as the sole way to invest, Fouse says, but as part of a larger protfolio strategy that includes actively managed funds as well. But he notes that as each year goes by, he becomes more convinced of the validity of a single approach.
Of the dozen actively managed Wells Fargo investment funds, 11 did better than the S&P 500 last year. The top performer had a 30 per cent return, while the 12th fund underperformed the index by only 0.5 per cent. But Fouse says this does not argue for merely finding a superior portfolio manager and against the indexing approach because of the difficulty in achieving consistency.
"There are of course some managers who outperform the market, but the problem is they aren't the same ones year after year," he says.