In an effort to offer actively-managed performance at a cost and risk more associated with an index fund, J.P. Morgan has introduced a hybrid fund, the SmartIndex Fund.
The fund is being marketed primarily to the defined contribution market and to a lesser degree, to large institutional investors.
J.P. Morgan has been able to get more involved in the defined contribution market after making an investment in American Century Investments of Kansas City last year. The partnership's new defined contribution division is based in Kansas City and offers bundled defined contribution services. J.P. Morgan could not offer these in the past because it did not do record-keeping. But American Century does and that ability initially attracted J.P. Morgan to American Century.
The J.P. Morgan Institutional SmartIndex Fund will make its stock selections based more on the S&P 500's sector weightings than on the individual stocks in the index. It will also seek out stocks that are undervalued, according to the fund's prospectus.
The fund's investment management practice has been used by J.P. Morgan in separate accounts since 1989 and the strategy has beaten the S&P 500 every year except its first year. The same approach has also been used successfully in defined benefit plans. J.P. Morgan officials believe it will be received as well by 401(k) participants looking for an index-like product and that it will help build the company's defined contribution business.
"We've had a tremendous amount of success in the defined benefit (market with this product). We think that it's going to be similarly attractive to the defined contribution side," said Rick Nelson, managing director and head of J.P. Morgan's U.S. structured equity group. J.P. Morgan manages $280 billion in defined contribution, direct benefit, mutual fund and private account business. American Century manages $70 billion.
Nelson believes that the fund will be attractive to defined contribution participants because it offers an index fund that has the ability to attain higher returns than the S&P 500.
The investment strategy has paid off over the years, if only by small margins. In 1997, J.P. Morgan private accounts using the strategy had a total return of 33.98 percent, while the S&P 500 had a total return of 33.36 percent. In 1996, such accounts returned 23.72 percent while the index had a return of 22.96 percent.
"It doesn't mean that the S&P is a dumb index," Nelson said.
Those who pick the stocks in the S&P 500 have concerns beyond performance and do not select winners and losers, said Nelson. While an index fund such as the S&P 500 is an indicator of the economy as a whole, the SmartIndex will lean on what it believes are the strongest companies of the index to produce returns higher than the index. The fund is expected to hold about 350 stocks, according to the prospectus.
"We think it captures the essence of why people like the index," Nelson said. "It has index-like risk and you have the potential for added performance." He said that J.P. Morgan does not now plan to offer the fund on a retail basis.
The minimum initial investment in the fund is $3 million and total annual operating expenses are 59 basis points.