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Outperforming the Nasdaq Ain't What It Used to Be

Why bother with Gary B. Smith's charts and trend lines, or Herb Greenberg's margins and bottom lines? You want a picture of the market? Just check my email.

Yep, right after the market free-falls, my letters are all about funds. Right when it's heading higher, everyone forgets funds. All questions are about stocks -- especially the sexy ones.

Why? Well, granted, it's handy to have someone else to blame when you're in tough times. And during the good times, it's nice to take credit for stock-picking.

But here's the real impetus for this trend. Usually right after the bear starts growling, fund firms start to tout their numbers. No ... not returns. Minus signs are no fun, even when funds are losing less than the indices. Rather, fund managers are finally outperforming the market.

No question, the contrast between bad and good times is pretty dramatic.

According to Morningstar, from the market peak on March 10 through last Friday, more than 90% of all U.S. diversified funds beat the Nasdaq. Not bad, especially when you consider that just 2% achieved that feat in the trailing five years.

The last time we saw this kind of outperformance by managers was the second quarter of last year. This followed years of humiliation, during which time all but a handful of portfolio managers had trouble keeping pace with the S&P 500 index.

Predictably, then, as you'll soon surely see, industry insiders and fund fans cheer, Our day has come again! Meanwhile, do-it-yourselfers lick their wounds and wonder, What happened?

Here's what I say: Who cares?

The fact that funds beat the Nasty Nasdaq during this downturn may mean market sentiment has shifted.

But stop right there. Don't automatically assume anything else. Are fund managers suddenly better stock pickers? Did they get Ph.D.'s from MIT or Jim Cramer brain transplants?

Of course not. Nor can you presume that the funds beating the Nasdaq are now the ones to own or that those falling behind need a heave-ho.

This is a good time to bring up the importance of using the proper benchmark (the correct yardstick) for measuring your fund's performance. The Nasdaq isn't that good unless you're measuring a tech-taut fund. And the S&P 500 is basically useless as a standard unless you're judging a large-cap U.S. fund.

So, if you're suddenly ready to congratulate that manager you were cursing a few months ago, think again. "Does it beat the Nasdaq?" simply is not the first question to ask about a fund's performance.

Well then, what is? How do you best assess the small-cap and mid-cap funds (nearly half of all equity funds) without the S&P? And what about international funds? There are the usual suspects: either the Russell 2000 or S&P SmallCap 600 is better for small-cap funds; S&P Midcap 400 is popular for mid-caps. Various Morgan Stanley Capital International indices are helpful in tracking overseas funds. I usually look at the MSCI EAFE Ex-Japan. It tracks the big stock markets of Asia, Europe and the Far East, excluding Japan.

But there are problems with these secondary indices too. Mainly, they don't take into account the style a manager uses, which can go in and out of favor as much as stock size. Without looking at relative performance (against peers), you don't really get a full picture. How does a fund stack up against comparable funds?

This is almost as easy to answer as checking out progress against the Nasdaq or S&P. I rely on Morningstar. Its categories are very specific (mid-cap value or small-cap growth, for example), weighing both the market cap of a fund's holdings as well as a manager's style, and performance is ranked in several trailing time periods.

This isn't to say you shouldn't keep an eye on the Nasdaq. How can you not? It's all anyone talks about. But the fund industry should hold its smug "I told you so." A win for active managers says as much about sector shifts as it does about their success in stock-picking.

Sorry You Missed Us

So sorry our show ("TheStreet.com" on Fox News Channel, 10 a.m. and 6 p.m. Saturday, and 10 a.m. Sunday, EDT) was pre-empted last weekend. I hope the transcripts helped you to get some insight. Be sure to tune in this weekend. We're going to poll the best minds in the business on how they figure out if we've seen a bottom in the market.
Brenda Buttner's column, Under the Hood, appears Thursdays. At time of publication, Buttner held no positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks or funds. While she cannot provide investment advice or recommendations, Buttner appreciates your feedback at TSCBrenda@aol.com .

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