Mr. Clements examines the reasons why actively-managed diversified
U.S. stock funds have been trailing the Standard & Poor's
500 Stock Index's gain while international funds have been able
to beat Morgan Stanley's Europe, Australasia, and Far East (EAFE)
Index. He argues convincingly in regards to U.S. stock funds but
less so regarding foreign funds.
U.S stock funds have badly lagged the S&P 500 Index in recent
years. Clements claims that investors are not comparing apples
to apples when they use the S&P 500 as the benchmark for a
diversified stock fund. The S&P 500 contains stocks with the
largest market capitalizations, and they have outperformed smaller
stocks over the past several years. This large-cap bias has made
it tough for funds with smaller stocks to keep pace with the S&P
500 Index. He recommends using the Wilshire 5000 Index of most
regularly traded U.S. equities, which includes both large and
small companies, as the benchmark index.
Clements provides the same reason for the apparently superior
performance of foreign funds: a flawed benchmark. EAFE had a high
weighting (about 62%) on Japan at the start of the 90's. With
Japan's miserable performance over the past several years, Clements
claims that it has been easy for international fund managers to
beat EAFE by simply underweighting Japan. But they made the right
call on Japan, so why shouldn't they be given credit for it? He
reasonably asserts that EAFE should be a better benchmark in the
future as Japan's weighting in the index has shrunk to appropriate
levels.
Review by Rahul Seksaria, Assistant Editor
