AlphaTrak 500: Trying to Beat the Market

By Monique McKenzie

Why settle for matching the stock market when you can beat it? That's essentially what managers of enhanced index funds try to do. But as the stewards of Metropolitan West AlphaTrak 500 have discovered, beating the market is easier said than done, at least on a consistent basis.

Metropolitan West is a well-regarded, Los Angeles-based bond shop. Several of its key managers spent time at Pimco, the nation's pre-eminent fixed-income manager. And, in fact, AlphaTrak 500 (symbol MWATX) relies primarily on the bond-picking expertise of its managers.

Subscribe to Kiplinger’s Personal Finance

Be a smarter, better informed investor.

Save up to 74%

Sign up for Kiplinger’s Free E-Newsletters

Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.

Profit and prosper with the best of expert advice - straight to your e-mail.

Sign up

AlphaTrak, which at last report had $157 million in assets, works this way: To get exposure to the stock market, the managers use a relatively small percentage of the fund's assets (about 4% to 5%) to buy futures contracts that track Standard & Poor's 500-stock index.

They then invest the rest of the assets in a diversified package of short-term bonds. If the returns of the bonds exceed the futures contracts' costs, which are tied to a short-term interest rate known as LIBOR, and fund expenses, then AlphaTrak should beat the S&P 500. The fund "utilizes our fixed-income skills to manage the portfolio's bonds and transfers those skills to S&P 500 futures," says Stephen Kane, one of the managers.

But are those skills enough to enable AlphaTrak to beat the index, which historically outpaces most actively managed diversified U.S. stock funds? Over the long term, AlphaTrak comes close to matching the market.

Since the fund's inception on June 29, 1998, through April 2, the fund returned 3.2% annualized, according to Morningstar. That trailed the S&P 500 by an average of 0.3 percentage point per year and Vanguard Index 500, a traditional index fund, by 0.2 percentage point per year. Over the same period, a similar enhanced index fund, Pimco StockPlus A (PSPAX), essentially tied AlphaTrak, nipping it by three one-hundredths of a percentage point per year, according to Morningstar.

But on a year-to-year basis, AlphaTrak's performance has been less consistent. In its nine full years of existence, AlphaTrak 500 has beaten the S&P 500 six times (by as much as 4.4 percentage points, in 2003) and trailed the index three times (by as much as four percentage points, in 2007). So far this year, the fund is lagging the benchmark by 0.6 percentage point. The Pimco fund has never lagged the index by more than 2.2 percentage points in a given year.

As with any bonds, those in AlphaTrak are susceptible to interest-rate risk (bond prices fall when yields rise) and credit risk. Lately, it's the latter that has weighed down performance. Because of the housing crisis, prices of many of the mortgage and asset-backed securities that MetWest tends to favor have been under pressure since the middle of 2007. The same holds for AlphaTrak's corporate bond holdings.

Although the fund is lagging the index so far this year, Kane insists that "2008 is the flip side of 2007." As the gap between the yields on the fund's beaten-down bond holdings and Treasury yields have widened, AlphaTrak's bonds have become much more attractively priced. Says Kane: "While the widening of spreads in the mortgage and asset-backed markets negatively impacted AlphaTrak in 2007, there is significant trapped value in the fund that will lead to solid performance for the remainder of 2008 and beyond."

To its credit, Metropolitan West ties its management fee on AlphaTrak to performance. That fee can range from nothing to 0.70%. The fund's latest reported expense ratio, which includes management and other fees, was 0.36%. Compared with most funds, that's a bargain. But it's significantly higher than fees charged by such traditional S&P 500 index funds as Vanguard Index 500 (VFINX), which charges 0.15% a year, and Fidelity Spartan 500 (FSMKX), which charges just 0.10%.

AlphaTrak's long-term record suggests that, like most actively managed funds, it will have trouble beating the S&P 500 over an extended period. But if you're bullish on stocks (remember, this fund essentially tracks the market) and believe that bonds that don't have Treasury in their names are due to recover, then AlphaTrak could be a solid choice over the next year or two.

If you do invest, keep in mind that because of its use of futures contracts, the fund generates lots of distributions and so is best suited for tax-deferred accounts, such as IRAs.