Sunday, January 14, 2007

When is an index really an index

While re-reading the last few chapters of William Bernstein's Four Pillars of Investing, I noticed a discussion regarding index funds: not all indexes hold all of the stocks that compose the index - some - perhaps dependent upon the specific index hold a statistical sample designed to replicate the overall behavior of the index.

While examining the prospecti of Black Rock's index funds I found footnotes where they reserved the right to use a statistical approximation of an index rahter than the actual index.

This of course made me curious - how close was there approximation to the actual index. I flipped through the prospectus discussing their s+p 500, international, small cap and bond indexes. In most cases their performance was similar to the index - their expense ratios. Unfortunately their expense ratios are very high compared to vanguard and schwab. Approx 0.6 percent is pretty ridiculous for an s+p 500 index -- fidelity's spartan is approx 0.08 percent -- black rock is almost 8 timesd more expensive. Frankly it's ridiculous. You end up paying more for lower perfomance.

I think the next posting I'll write is a comparison of the leading index fund family expense ratios.

Regards, makingourway


mOOm said...

But if they end up matching the index anyway it doesn't matter. It would kind of be silly to actually buy all the stocks in the index if I can replicate by simpler methods for example a mixture of cash and futures contracts will work or buy SPY or a sample of stocks, or some combination.... but probably doesn't rally matter for a fund as they can do a basket trade where they just pay a given rate per share for buying the basket and the computer executes the trade.

makingourway said...

moom - the "if they end up matching the index" is the point.

Are they really doing so and how consistently?

If it does match very consistently, it certainly makes sense to do so.