INDEX FUNDS AND ACTIVE MANAGERS

It's hard to argue with success. Take S & P 500 index funds, for example. Up, on average, 12.92 percent through Nov. 11, these large-cap passively managed mutual funds have provided their shareholders with an average annual total return of over 26 percent for the past five years, according to Lipper, Inc. That's not too shabby for any type of fund. Ever.

A couple of reasons for the success of the S & P 500 index funds are their costs---they are cheap to manage and don't really incur transition costs because of their buy-and-hold strategy---and the market. Take a step back and look at what's been fueling this bull market throughout the years and you'll see that large-cap stocks come out on top.

So, being a winner in a pool that's designed to reflect only what's in it, when the market is on your side, makes good sense. What isn't so smakrt is assuming that you'll always come out on top with every type of index fund.

Researchers at Morningstar, the Chicago-based mutual fund research company, looked at the 5-year performance record of seven different types of index funds and compared them with the performance of actively managed like funds. Here's a look at the different investment styles, their benchmarks, and the percentage of actively managed funds that beat their respective indexes:

• Large Growth: 6 percent of actively managed funds beat the Vanguard Growth Index over the past five years ending in December 1998.

• Large Blend: 4 percent of actively managed funds beat the Vanguard 500 Index.

• Large Value: 17 percent beat the Vanguard Value Index.

• Mid-Cap Blend: 30 percent of actively managed funds beat the Dreyfus MidCap Index.

• Small Growth: 91 percent of actively managed funds beat the Wilshire Target Small Growth Index.

• Small Blend: 54 percent beat the Vanguard Index.

• Small Value: 81 percent of actively managed funds beat the Wilshire Target Small Value Index.

As the numbers imply, index funds tend to be great performers when the type of stocks they represent---small, medium, or large-caps---are in vogue. When they aren't, it's a stock-pickers world.

John Rekenthaler, Morningstar's research director, explains why on http://www.morningstar.com/fundinvestor, "Since indexes are pure plays on a particular asset class and funds are not, the bottom line must be that when indexes are comapred to gennerally similar funds, the indexes are rewared for their purity during good times and punished during bad times."

So, while index funds can be great investments, don't assume that all of them will be all of the time. That means there is plenty of room for actively managed funds in your portfolio. Why? Because the percentages show that, depending on asset class, there have at least been a few----if not a majority--of portfolio managers who have rewarded their shareholders more handsomely than the passively managed index funds have.

And if it's price that's been your main draw to index funds, be careful not to gett too hooked investing only in inexpensive funds.

Many investors won't even consider buying shares of an equity mutual fund if its expense ratios exceed the average, currently about 1.4 percent per year account to Morningstar. But investing into a fund just because it's cheap to run ought not be the main---or only--- criteria for selecting it. Where it invests, who's running it, what it's track record has been are just as important.

For instance, annual expenses run high---currently about 1.96 percent per year---on David Alger's Spectra Fund, (1-800-711-6141). When asked about the high expenses, Alger says that basically that you get what you pay for. And his point holds water: Through Nov. 16, the Spectra Fund's year-to-date performance was up over 44 percent. For the last five years ending Oct. 30, it's average annual total return was 33.71 percent.