Wallet, Psyche Suffer as Whipsaw Proves Unkindest Cut.

ONE of the nastiest experiences investors will ever face is The Whipsaw.

If the term is unfamiliar, picture a double-handled tool that saws a log going one way and cuts it some more coming back. That image serves to describe any financial misadventure that hurts you not just once, but twice or more. Besides the compound damage to the wallet, a whipsaw can be hard on one's psyche.

The Bloomberg Financial Glossary defines whipsaw as "buying stocks just before prices fall and selling stocks just before prices rise in a volatile market, often as the result of misleading signals." That's a good example; in practice whipsaws come in many different forms.

Consider the recent history of the $11.6 billion Vanguard U.S. Growth Fund, which changed managers in June, replacing Lincoln Capital Management with Alliance Capital Management as the "sub-adviser" in charge of choosing investments for the fund.

Double trouble

Lincoln, which had been at the helm since 1987, said it "consistently adhered to a pure growth philosophy" in managing the fund, and Vanguard didn't say why it made the change.

Independent analysts, though, pointed to a double dose of poison involving Internet and other fast-moving "technology" stocks. U.S. Growth "underperformed when high-growth stocks were rockin' in 1999, then assumed a bolder, technology-heavy stance just in time to bear the full force of the sell-off in 2000 and early 2001," said a Morningstar Inc. analysis.

According to Bloomberg data, U.S. Growth gained 22 percent in 1999, trailing almost two-thirds of other growth funds, That year the Nasdaq Composite Index soared 86 percent. In the 18 months from the end of 1999 to mid-2001, the fund lost 40 percent; not much less than the Nasdaq's 47 percent drop.

Now, we learn from information on the Vanguard Web site, the portion of the fund allocated to technology stocks has been slashed to 18.5 percent from 44.2 percent at mid-2000. If the market gremlins that delight in whipsaws are feeling frisky, the tech stocks U.S. Growth dumped will soon stage a spirited rally. Veteran investors at the Chicago-based Oakmark Fund - and the fund's former manager, Robert Sanborn know how that kind of thing goes. Sanbom was replaced in March 2000 after almost a decade as manager of the fund. In a market climate that had turned hostile to Sanborn's uncompromising "deep value" style, the fund was reeling. It had lost 19 percent since the end of 1998, while the Standard & Poor's 500 Index gained 19 percent.

Reversal of fortune

From almost the exact moment of Sanborn's departure, the bargain stocks in which he specialized began a dramatic comeback. One of his favorites, Philip Morris Cos., had fallen 59 percent since the end of 1998. Now it jumped 70 percent in less than five months.

Whipsaw tales are often told to admonish investors against trading too often, and to encourage them to stick to their convictions through tough times. But you don't have to be overactive or indecisive to get whipsawed. As Sanbom proved, you can be holding fiercely to your convictions while market conditions change.

Meanwhile, the Oakmark Fund, with new managers Bill Nygren and Kevin Grant working in a climate much friendlier to the value style, snapped back to life. In the past 16 months it has gained 46 percent while the S&P 500 has dropped 18 percent and the Nasdaq Composite has plunged 55 percent.

Lately, investors who had been fleeing value funds such as Oakmark have started pumping money back in. Here's hoping they don't get whipsawed.

Chet Currier is a columnist with Bloomberg News.

Index Funds Defying Functions of Markets

contrary to the adage, there is something older than yesterday's news. How about a colum infrom 25 years ago?

I wrote a column in 1976 about the potential drawbacks of index funds. Even then it was a quixotic argument, easily ignored in die dramatic rise of the "passive" school of investing.

And yet the question still bears thinking about Don't these funds, by their refusal to favor one stock over another, subvert the basic economic purpose of the markets?

By dispensing. with the effort and expense of research and minimizing trading costs index funds gain an edge against the average managed fund. I didn't dispute this compelling rationale then, nor do I now. Only it isn't the whole story.

The Vanguard 500 Index Fund is the largest of all mutual funds, with $91.5 billion in assets. That and hundreds of other index funds account for close to 10 cents of every dollar invested in stock funds. Also, the c6ncept has been the basis for one of the latest innovations in investing, exchange-traded funds.

So what's not to like? Well, index funds go against a prime function of the markets steering capital to places where it can be put to the most productive use.

Index investors don't pick and choose among competing investment possibilities; they allocate their money by default according to whatever decisions are made by other investors as a group.

The more "inefficiencies" arise in any market, the more moneymaking opportunities present themselves to investors willing to stake their money on their judgment.

Chet Currier