Focused Index Funds: Are They For You?

Posted on 27. Oct, 2006 by in Saving & Investing

I read an interesting story this morning in the Wall Street Journal which highlighted the “boldness” of the Pioneer Cullen Value fund for owning shares of just 41 companies.

For those of you who may not know, an index fund is a very diversified mutual fund – and one of my personal favorites. These funds usually own shares in most, of not all, companies within a certain index – such as the S&P 500. This way, when the S&P 500 goes up, so does the value of your mutual fund. And if one stock takes a plunge, it’s offset by 499 other stocks – just like the stock market itself. I really like index funds because they are fairly risk-adverse and provide a steady increase in return over the years.

magnifyinglgass.jpgSo when you compare traditional index funds to the Pioneer Cullen Value fund you can see why their index fund is a bit different. Apparently, the strategy behind the fund is to access a part of the market where it looks like it will be hard to beat the index. But, as you can probably imagine, the volatility of this type of fund is amplified due to the decrease in diversification.

But the real question is, does this type of fund work? Is it for you?

The Wall Street Journal mentions a 2004 study conducted by researchers at the University of Michigan and the University of British Columbia who looked at the returns of actively managed mutual funds from 1984 to 1999. They found that concentrated portfolios slightly outperformed — even on a risk-adjusted basis — their diversified counterparts. A sampling of 10 top-notch focused funds returned an average annual 17.3% over the past three years, clobbering the Standard & Poor’s 500-stock index by six percentage points.

Although the focused funds seemed to outperform their diversified counterparts, you need to assess your own financial situation to see if the additional risk is something that you can afford to take on right now. If you are in the beginning phases of saving for the future, than focused funds might be a good opportunity for you to beat the market. However, if you don’t have the time for the volatility in the market to average itself out over time, then you might want to look for other options.

But regardless of what you plan to do personally, I will now give focused funds a second look when it comes to finding an index fund.

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2 Responses to “Focused Index Funds: Are They For You?”

  1. kral oyun

    06. Nov, 2006

    thanks

  2. Abi

    06. Nov, 2006

    I heart index funds. No really, I do. I bring up investing with Vanguard while I’m at cocktail parties. It is definitely a problem.

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