2004: What a Year For Indexing!

January 03, 2005

In a year that may have fallen flat for many investors, index products shone, in terms overall performance, splashy new launches and soaring asset growth.

With 2005 still a wobbly newborn, it's time to turn again to that hallowed tradition: the year-in-review article. Usually an exercise in nostalgia, this year it's an exercise in celebration.  Because by any standard, 2004 was quite a year for the world of indexing, and 2005 looks promising as well.

Top Performers

Land of the giants, it may be, but the U.S. market remained the domain of the little guy.  For the sixth consecutive year, small caps trumped large caps convincingly in 2004.  The small-cap Russell 2000 returned 18.6% for the year, against 9.0% for the large-cap S&P 500. The last time large caps beat small caps, Bill Clinton was still President and America Online was a hot stock.

Following the David-beats-Goliath theme, emerging markets bested developed markets in 2004 as well: according to MSCI, emerging markets returned almost 19% against just 11% for the developed world.  (These results may have changed following the unimaginable tragedy of the tsunami: to donate money to the relief effort, click here: http://www.google.com/tsunami_relief.html).

Of the largest index mutual funds, the top performer as of November 11th was the Energy SPDR (XLE), which surged 47% for the year on the back of strong oil and natural gas prices.  The Energy SPDR is followed by a handful REIT funds, which continued to surge despite an uptick in interest rates: Vanguard's REIT index led the charge with a 28% return (VGSIX).

Reflecting the continuing weakness of the U.S. dollar, a spate of iShares country funds came in with stunning performances, with iShares Austria topping out the list with a 73.10% one-year explosion.

Vanguard's 500 Index fund (VFINX) retained its top spot on the "most assets" list, with over $80 billion in assets at year-end (and well over $100 billion if you count all the different share classes of the 500 fund). Even at $80 billion, the Vanguard 500 remains not only the largest index fund, but also the largest mutual fund in the world.  Hot on its heels, however, was an ETF - the S&P 500 SPDR, or SPY - which saw its asset count swell to $58 million - making it now the second largest index fund, and the fifth largest mutual fund overall.

You thought the market was flat in 2004?  Not for everyone.  For U.S. investors, aiming your dart away for the dollar and U.S. large caps, and toward oil and resources and small caps served you well in 2004.   There were a large number of outstanding performers in terms of countries, regions, sectors and styles.  And since ETFs are now practically anywhere there's an asset class (or a sub- or sub-sub-asset class), ETF outperformers abounded.

The following page shows that a cool 63 of the 128 ETFs with enough track record to have full-year returns for 2004 enjoyed a late 1990's flashback return of over 15%.  Bear in mind that none of the Vanguard Sectors, nor any of the more than 35 U.S. ETFs launched in 2004, make this list.  Just for fun, we show the bottom 20 as well.  Even the 10th worst returner (which was the Lehman Aggregate iShare) came in at 3.49%.  And the 20th lowest performer of the 128 topped what I recall as the standard bank return of 5% (good luck reaching 1% with your passbook savings these days), with large U.S. growth returning 5.68% in the form of the S&P 500 Barra Growth iShare.

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