If Looking For Top Fund Results, Just Check The Index Few Specialty Mutual Funds Can Match Gains Of S&P;

Do mutual funds really need managers? Do investors really need mutual funds?

Outrageous as those questions may seem - particularly to people who earn their livelihood managing or selling mutual funds - they seem perfectly legitimate in the wake of yet another quarter in which the great majority of funds did worse than the market averages.

In the three months ended June 30, the stocks in the Standard & Poor’s 500 index shot up 9.55 percent (assuming reinvestment of dividends). During the same period, the average general equity fund gained just 8.71 percent, according to New Jerseybased Lipper Analytical Services.

That gain would be respectable for a full year ordinarily, but it is overshadowed this year by the broad market averages.

Only 32 percent of general equity funds - those investing in diversified U.S. stocks - beat the S&P 500 index during the quarter. That was actually an improvement from the first quarter, when the S&P rose 9.73 percent and just 10 percent of the funds did better.

For the first half of the year the index was up 20.25 percent while the average general equity fund rose 16.6 percent; only 17 percent of the funds beat the index for the full six months.

Not surprisingly, so-called index funds - those whose portfolios simulate the composition of the S&P 500 - were the best-performing of the seven general equity-fund groups tracked by Lipper, with an average gain of 9.38 percent during the second quarter. (They trailed the actual index slightly mainly because of administrative fees.)

So, should mutual-fund investors all switch to index funds? Or do they even need funds at all?

Should they just buy a sampling of the big, blue-chip companies that dominate the S&P 500, sparing themselves mutual-fund commissions and fees?

Perish the thought, say gurus.

“In a strong bull market, the S&P always leads the funds,” says Kurt Brouwer, of Brouwer & Janachowski in San Francisco. “The index is concentrated in the big companies that spearhead bull markets.”

But smaller companies eventually will have their day, Brouwer adds. During the 1970s, an extremely tricky and difficult decade for investors, small-capitalization stocks did far better than big companies, and investors who loaded up on S&P 500 stocks fared poorly.

Even if you look back over the past three years, small-cap stocks generally have done better than big caps, Brouwer observes.

If you compare the S&P 500 with the Russell 2000, which is essentially a small-cap index, the S&P is ahead for the latest quarter - 9.55 percent vs. 9.03 percent - and for the latest 12 months, with an edge of 26.07 percent to 18.32 percent.

But during the past three years the Russell is well ahead with a gain of 51 percent, compared with 44 percent for the S&P. “For most of the ‘90s, the S&P has not necessarily been the optimum place to be,” Brouwer concludes. “It varies.”

Craig Litman, of Litman/ Gregory in Larkspur, acknowledges that the current market environment “makes it harder to make the case that management helps,” but he advises fund shareholders to “hang in there.”

He explains: “Simply because your fund manager has trailed the index doesn’t mean he or she isn’t a good manager. If their investment style is consistent with what you’re looking for, and if they continue to do well relative to their peers, I would stick with them.”

Specialty funds are usually where the action is in any given quarter, but the action rarely stays with any specialty for any great length of time.

The most rousing performances among all 2,834 equity funds in the Lipper universe last quarter came from the 39 science and technology funds, which were spurred by acrossthe-board run-ups in computerrelated issues.

“I would be pretty nervous about jumping into technology funds now,” says Brouwer.

“The run-up has already occurred. When you try to chase a run-up, you’ll probably get killed.”

The worst group performance during the latest quarter was turned in by the 12 funds that specialize in Japanese stocks. They fell an average of 6.17 percent.

Bond funds, which performed terribly in 1994, had a second consecutive strong quarter. Funds specializing in investment-grade corporate bonds were strongest, with an average 6.7 percent gain.