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Index funds and strategy
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February 8, 2000: 7:28 a.m. ET
Manager of the Vanguard 500 gives straight answers to probing questions
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NEW YORK (CNNfn) - Gus Sauter, manager of the Vanguard 500 Index Fund, the nation's second largest mutual fund, says his portfolio attracts the sophisticated investor.
At $104.7 billion in assets, the Vanguard 500 Index Fund has been running a close second to the $105.9 billion Fidelity Magellan Fund in recent weeks.
The Vanguard fund, which is heavily weighted in technology stocks, also invests in the financial services sector and industrials. The fund, which tracks the S&P 500 Index, has gained an average 28 percent over the past five years.
On Monday, Sauter spoke with CNNfn and discussed his stock strategy, which along the way has included investing in some of the biggest names, such as: Microsoft (MSFT: Research, Estimates); General Electric (GE: Research, Estimates); Cisco (CSCO: Research, Estimates); and Wal-Mart (WMT: Research, Estimates).
CNNfn: Index funds have had a tough time of it. You have a very nice well-proven track record. However, last year, for the first time in a while, actively managed mutual funds actually managed to outpace the index funds by just a little bit, 27 percent versus 21 percent. What kind of investors is attracted to index funds? And why would they want to put their money there?
Sauter: Well, there was an interesting statistical anomaly that happened last year. Whereas you point out that the average equity fund provided a 27 percent return, interestingly though, still 53 percent of equity funds underperformed the 21 percent return of the index. So there were a few funds that really dragged the average up because they had extraordinary returns.
Insofar as what types of investors are attracted to index funds, typically they tend to be more sophisticated investors. We look at our investor base and find that they tend to have a longer-term focus. Indexing really is a long-term buy-and-hold strategy. It does not provide advantages for short-term investors. So they are sophisticated long-term investors.
CNNfn: As far as the fund's strategy goes, with the [Vanguard] 500 Index Fund, do you match weighting for weighting against sectors in the S&P 500, or do you have some freedom here to maybe overweight, invest more in the technology side, and underweight, say, in sectors that are not performing as well?
Sauter: We use a plain vanilla strategy. So, in other words, we do weight the stocks exactly the way they are weighted within the index. If Microsoft happens to be about 4-1/2 percent of the index, we own about 4-1/2 percent in the fund. It is very precise.
CNNfn: You have another fund that I want to talk to you about, as well, and it is the total market growth fund. Do you have a little more flexibility in there, and what's the difference between index fund and the total growth fund?
Sauter: We have a total market fund, which is a -- that particular fund invests in an index that covers the entire U.S. market, which is an index called the Wilshire 5000. It consists of about 7,200 stocks in total, but it literally is the entire U.S. market. We own about 3,200 of those stocks, because it is just very onerous to own 7,200 stocks.
CNNfn: ... You have enough money to buy them all, don't you, Gus?
Sauter: We definitely do. In fact, you might almost say too much money. The stocks that we don't own are terribly illiquid, and the costs of owning them actually outweigh the benefits of owning them.
CNNfn: One quick question here: I'm wondering what you are seeing in terms of money flows? Are you still seeing the flows go into the equity funds or have you seen a shift to bond funds yet?
Sauter: No, we've seen very strong flows this year, and through the end of last year, about what we have experienced over the last couple of years. Seems to be more of the same. 
--compiled by Antoinette Coulton
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Vanguard Group
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