Investors' enthusiasm for index funds has not evaporated, but it subsided notably in March.
Index funds suffered net redemptions of approximately $165 million in March, a reversal of fortune for a category which had roughly $2 billion of net sales in February and nearly $58.6 billion in net sales in 1999, according to estimates from Financial Research Corp. of Boston, a financial services tracking and consulting firm. The $2 billion in sales in February was the lowest monthly total for index fund sales since October 1998, when the category had approximately $1.3 billion in sales, according to FRC.
March also marked the first time the index fund category had net redemptions since at least March 1998, according to FRC. Data for earlier periods was not immediately available.
The sagging popularity of index funds in March even touched the largest and best recognized index fund, the Vanguard 500 Index Fund. The Vanguard 500 Index Fund had net redemptions of approximately $829 million in March, according to FRC. That is a miniscule amount for a fund that had $107.4 billion in assets under management as of March 31. Nevertheless, net redemptions are a rare occurrence for the Vanguard 500 Index Fund.
The last time the fund suffered net redemptions was August 1993, according to FRC. The fund had $13.2 billion in net sales in 1999, the highest level in the fund's history.
The shift away from index fund sales comes as actively- managed funds are outperforming index funds. David Haywood, an FRC consultant, attributed the decline in sales to the relative decline in performance of index funds.
"It's a pretty clear indication that people are chasing performance," Haywood said of the decline in sales.
Investment performance this year has centered on individual stocks rather than broad categories of stocks. The S&P 500 had a return of 0.06 percent this year through April 27, according to Lipper of Summit, N.J., the fund tracking and consulting firm. The average actively-managed U.S. diversified equity fund had a total return of 1.84 percent during the same period, according to Lipper.
Vanguard Group of Malvern, Pa., does not comment on sales figures for specific funds, said John Demming, a spokesperson for Vanguard. Vanguard offers both index and actively-managed funds. It does not break out sales in the two fund categories, he said. Vanguard had net sales of $623 million in March in stock and fixed-income funds, he said.
The recent slowdown in index fund sales does not foreshadow the demise of index funds as a popular investment choice, consultants said. Index funds have become embedded in mutual fund distribution in recent years thanks to the proliferation of index funds now offered in retirement accounts, according to industry consultants.
"I don't think people need to be closing down the shop in this area," said Ann Mahrdt, a senior consultant in the Chicago office of the Spectrem Group of New York, a consulting, research and investment banking firm. "There is a place for these funds."
Plan sponsors increasingly have selected equity index funds as an option in defined contribution plans, according to Spectrem. Fifty-one percent of plan sponsors offered equity index funds as an investment option in 1999, according to Spectrem. That is an increase from 41 percent in 1995 and 47 percent in 1997, according to Spectrem.
Index funds are likely to have more redemptions in coming years because the base of investors in those funds has expanded, Mahrdt said. New investors, including some who are nearing retirement age, have invested in index funds because they consider index funds a comparatively low-risk method of gaining exposure to equities, Mahrdt said. Those investors are more likely to redeem than others because they are apt to reduce equity risk in their portfolios as retirement approaches, Mahrdt said.
The slowdown in index fund sales largely will halt the introduction of new index funds, Haywood said. Index funds have lower profit margins than actively-managed funds and usually require substantial size to become profitable for firms. Fund complexes have started index funds in recent years as a defensive measure to combat the popularity of Vanguard's offerings, Haywood said.
"If managers can avoid offering index products, they're going to do it," Haywood said.