Four Intriguing Index Funds That Deserve Attention

When most investors think about index funds, the first name that likely comes to mind is Vanguard--and for good reason. Vanguard's history is built around the index fund concept--the company bravely launched over 30 years ago the first retail index fund based on the S&P 500 Index (ironically dubbed "Bogle's folly" at the time after firm founder John Bogle). Vanguard's rock-bottom index fund fees--one of the primary advantages of passively managed funds--are also laudable.

But Vanguard's dominance over the index-investing landscape has overshadowed some worthy players. Dimensional Fund Advisors, for instance, is a much smaller shop than Vanguard, but it provides plenty of appealing index fund choices. In fact, the index options at DFA outnumber the offerings at Vanguard. And DFA offers a more exotic array of choices, such as Emerging Markets Social Core Equity (DFESX) and U.S. Sustainability Core (DFSIX), whereas Vanguard tends to stick with plain-vanilla indexes such as the S&P 500 Index and other commonly known market indexes.

Another lesser-known player that offers solid index choices is Bridgeway. This interesting, shareholder-friendly shop is smaller than DFA, but that doesn't limit its appeal. Bridgeway has 11 funds--mostly quantitatively run; two of which are index funds. Bridgeway's ability to be nimble in the micro-cap space is an advantage especially over behemoths such as Vanguard or Fidelity whose enormous size limits their ability to operate as smoothly.

Both DFA and Bridgeway have a bias toward small- and micro-cap funds (stocks less than $500 million in market cap) based on research that suggests smaller companies outperform their larger counterparts over the long term. Both firms also boast impressive quantitative resources and credentials.

What follows is a short list of these passively managed, non-Vanguard funds that we think deserve more attention. These funds represent a little something different from the standard run-of-the-mill index fund. And some give investors access to notoriously expensive categories--such as micro-cap and small-cap emerging-markets funds--at a fraction of the cost of equivalent actively managed strategies.

 Bridgeway Blue-Chip 35 Index 
This fund has plenty of appealing traits. First, it operates in the mega-cap arena and offers pure exposure to some of the market's largest names (which tend to hold up better during market downturns). The average market cap for this fund is $118 billion, which is more than 2.5 times the average market cap for the S&P 500 Index. Second, the fund tracks its own proprietary index of 35 equally weighted stocks. We like Blue-Chip's equally weighted scheme because it helps to mitigate risk by not letting winners ride too high (a common complaint against many market-cap-weighted index funds). Indeed, the fund's risk measures are a bit less than the overall market's. Finally, the fund's rock-bottom expense ratio is a bonus. At just 0.15%, the fund has a lower price tag than Fidelity 100 Index --one of the few other mega-cap index offerings.

 Bridgeway Ultra-Small Company Market (BRSIX)
At the opposite end of the spectrum as Bridgeway's mega-cap index fund is the svelte Ultra-Small Company Market. This index fund gives investors access to the notoriously expensive (and usually high-turnover) category of micro-cap investing, at a fraction of the cost of most actively managed micro-cap funds. Also, lead manager John Montgomery uses proprietary trading techniques to reduce transaction costs and to keep the tax man at bay, making this a nice fit in taxable accounts. We also like this fund's distinctiveness in terms of its chosen index. It tracks the thinly followed CRSP Cap-Based Portfolio 10 Index--a benchmark consisting of the smallest 10% of NYSE-listed equities (based on market cap).

 DFA U.S. Micro Cap I (DFSCX)
This fund has one of the lowest micro-cap fund price tags around. The fund's 0.52% expense ratio is less than the aforementioned Bridgeway fund, which gives it a slight leg up over that fund. DFA U.S. Micro Cap I tracks the smallest 5% of U.S. exchange-listed stocks and has more than 2,000 individual holdings. Such a large number of holdings helps mitigate the risk that is inherent in this racy category. (Small companies lack the resources to weather market downturns.) However, the fund is closed to new investors and requires purchase through a financial advisor.

 DFA Emerging Markets Value I (DFEVX)
Another interesting option from DFA is its Emerging Markets Value fund. This fund merges emerging-markets index investing with the academic research that suggests smaller and value-oriented stocks outperform their larger-growth brethren over time. Lead manager Karen Umland blends conventional market-cap-weighted indexing with small-cap and value tilts in what academics Eugene Fama and Kenneth French call a "three-factor model." The real world seems to match up with the research: Over time, DFA Emerging Markets has one of the best 10-year records in the diversified emerging-markets category. The fund has all the appealing traits of typical index funds, such as rock-bottom turnover, low fees, and a large number of stocks, which helps to limit stock-specific risk that is inherent in this hot category.

Not Just for the Core
While big index funds based on the S&P 500 Index (and even the whole stock market) are often touted as a good core for an investor's portfolio, we think the aforementioned funds are worthy candidates to help round out a portfolio. They offer valuable diversification benefits and still retain all the positive features of most index funds--such as low costs and low turnover. For example, Bridgeway's mega-cap offering gives investors dirt-cheap access to the market's largest names, which could add stability to a portfolio during market downturns. At the opposite end of the spectrum, micro-cap index funds not only provide valuable diversification benefits, but also give investors who subscribe to the "smaller is better" theory a supercharged way to utilize that research (at a low cost). The following table illustrates the diversification benefits of these unique index funds.

A Word of Caution
With the exception of the Bridgeway's mega-cap Blue-Chip 35 Index, the funds mentioned are not for the faint of heart. They are highly volatile and should be used only sparingly (5%-10% of assets) as part of an already well-diversified portfolio. Additionally, the potential diversification benefits of these funds are best captured by regular rebalancing, which usually means selling winners and buying losers--something easier said than done.

Still, these unique funds are worth a look for investors who want a passive approach outside of the traditional index offerings.