NEW YORK (

TheStreet

) -- Investors have been disappointed by the performance of their S&P 500 funds. During the past decade,

Vanguard 500 Index

(VFINX) - Get Report

, the granddaddy of index funds, fell 0.9% annually and trailed 55% of large blend funds, according to Morningstar.

But not all S&P 500 funds have sunk into the red. In the past 10 years,

Morgan Stanley Equally Weighted S&P 500

(VADAX) - Get Report

returned 3.8% annually, exceeding 92% of large blend funds.

The Morgan Stanley offering is one of a growing group of nontraditional index funds. Some of the new funds hold an equal weight of each stock in the benchmark. Other funds weight stocks according to fundamental factors such as dividend yields. During the turbulence of the past year, many of the nontraditional funds outperformed the conventional S&P 500.

So far, investors have paid little attention, and the new funds continue to account for a tiny percentage of all assets in index funds. But that could change if the funds continue to beat the conventional benchmarks.

In traditional S&P 500 funds, stocks are weighted by market value, with bigger stocks accounting for more assets. So

ExxonMobil

(XOM) - Get Report

, the largest stock in the index is 4.2% of assets, while No. 2,

Microsoft

(MSFT) - Get Report

, accounts for 2.2%.

New York Times

(NYT) - Get Report

, one of the smallest members of the S&P 500, is only 0.01%.

Most academic researchers favor cap weighting, saying it gives a true picture of the actual holdings of investors. The academics say index funds should simply mimic the markets -- not try to outperform.

Proponents of the newer index funds argue that the traditional benchmarks have a major flaw: overweighting a few winning stocks. That problem became obvious in the late 1990s when technology stocks soared. As shares such as

Intel

(INTC) - Get Report

and

Cisco Systems

(CSCO) - Get Report

posted higher market caps, S&P 500 index funds had to shift assets from low-priced stocks into the high flyers. By the end of the rally, the index had a huge weighting in technology stocks. When those fell, the index funds sank sharply.

Equal-weight index funds aim to avoid overweighting. When a stock enters the S&P 500, Morgan Stanley Equally Weighted puts 0.2% of assets into the new holding. If a stock climbs to about 0.22%, the fund rebalances, selling overweighted shares.

Compared to the conventional S&P 500, equal-weighted funds have a heavy weighting in smaller stocks. So the nontraditional funds have excelled during periods when small stocks led the markets. Beginning in 2000, Morgan Stanley Equally Weighted beat the standard benchmark for six years in a row. The fund lagged behind in 2008 when investors sought safety in big blue chips. With smaller stocks leading so far this year, the fund has returned 37%, outdoing the cap-weighted benchmark by 17 percentage points.

To track the equal-weight benchmark using an ETF, consider

Rydex S&P Equal Weight

(RSP) - Get Report

. Another option is the open-end fund

Bridgeway Blue-Chip 35

(BRLIX) - Get Report

. Holding roughly equal positions of 35 of the largest stocks, Bridgeway has about 3% of assets in

Google

(GOOG) - Get Report

and 2.8% in

Apple

(AAPL) - Get Report

.

Investors who want to follow a fundamental benchmark should consider

Schwab Fundamental US Large Company

(SFLVX)

. To use an ETF, try

PowerShares FTSE RAFI 1000

(PRF) - Get Report

. Fundamental funds weight stocks according to financial measures such as dividends or sales. Schwab tracks the FTSE RAFI US 1000 Index, which weights stocks based on several factors, including dividends, earnings and sales. Under the RAFI system, a company with greater sales receives a heavier weighting. Partly because banks have big sales totals, Schwab's largest holding is

Bank of America

(BAC) - Get Report

, which accounts for 5.9% of assets.

Citigroup

(C) - Get Report

accounts for 2.6%.

The strengths and weaknesses of the fundamental approach were highlighted during the market turmoil of the past year. As the credit crisis unfolded, financial stocks cratered, and their weighting in the conventional S&P 500 dropped from 17% in 2007 to 10% by the spring of 2009. Meanwhile, the financial weighting in the RAFI benchmark stayed fairly stable at around 20%.

The falling weight of financials helped the conventional S&P 500 move past the RAFI index in 2008. During the second half of the year, the S&P 500 lost 28%, about half a percentage point better than RAFI. But this year, RAFI has raced ahead as financials recovered. For the year to date, Schwab Fundamental returned 40%, racing ahead of the S&P 500 by 20 percentage points.

Can the fundamental funds continue outperforming cap-weighted benchmarks? That's hard to know. But the experience of the past year demonstrates that the funds can make interesting additions to portfolios. Because they sometimes outshine the markets, equal-weight and fundamental funds can help to diversify portfolios that are heavy with traditional cap-weighted funds.

Stan Luxenberg is a freelance writer who specializes in mutual funds and investing. He was formerly executive editor of Individual Investor magazine.