MERRILL LYNCH
INDEX
FUNDS, INC.
[GRAPHIC OMITTED]
STRATEGIC
Performance
Quarterly Report
September 30, 1999
<PAGE>
MERRILL LYNCH INDEX FUNDS, INC.
Officers and Directors
Terry K. Glenn, President and Director
Jack B. Sunderland, Director
Stephen B. Swensrud, Director
J. Thomas Touchton, Director
Robert C. Doll, Senior Vice President
Joseph T. Monagle Jr., Senior Vice President
Christopher G. Ayoub, Senior Vice President and
Portfolio Manager
Gregory Mark Maunz, Senior Vice President and
Portfolio Manager
Eric S. Mitofsky, Senior Vice President and
Portfolio Manager
Jeffrey B. Hewson, Vice President and
Portfolio Manager
Donald C. Burke, Vice President and Treasurer
Ira P. Shapiro, Secretary
Custodian
For Merrill Lynch Aggregate Bond Index Fund,
Merrill Lynch S&P 500 Index Fund and
Merrill Lynch Small Cap Index Fund:
Merrill Lynch Trust Company
800 Scudders Mill Road
Plainsboro, NJ 08536
For Merrill Lynch International Index Fund:
State Street Bank and Trust Company
P.O. Box 351
Boston, MA 02101
Transfer Agent
Financial Data Services, Inc.
4800 Deer Lake Drive East
Jacksonville, FL 32246-6484
(800) 637-3863
<PAGE>
Merrill Lynch Index Funds, Inc., September 30, 1999
DEAR SHAREHOLDER
We are pleased to provide you with this quarterly report for Merrill Lynch Index
Funds, Inc. In this report, we will discuss the investments and performances of
Merrill Lynch Aggregate Bond Index Fund, Merrill Lynch International Index Fund,
Merrill Lynch S&P 500 Index Fund and Merrill Lynch Small Cap Index Fund.
(Complete performance information can be found on pages 6 and 7 of this report
to shareholders.)
Merrill Lynch Aggregate Bond Index Fund
The primary investment objective of Merrill Lynch Aggregate Bond Index Fund is
to seek to provide investment returns that, before expenses, replicate the total
return of the unmanaged Lehman Brothers Aggregate Bond Index. This Index is a
highly recognized and widely referenced benchmark and often used when measuring
performance in the investment-grade fixed-income market. For the quarter ended
September 30, 1999, the Fund's Class A and Class D Shares had total returns of
+0.77% and +0.61%, respectively, compared to a total return of +0.68% for the
Index.
At September quarter-end, there were 5,441 securities in the Index, emphasizing
securities from three major high-quality investment sectors. The weighting of
each sector is determined by the relative market value of all eligible
securities outstanding within the three sectors. As of September 30, 1999, the
US Government and agency bond sector was the largest, with 1,018 issues
representing 42.6% of the Index. The US Government agency mortgage-backed
securities (MBS) sector was the next largest at 35.2% with 699 securities, and
investment-grade corporate securities accounted for 22.2% of the Index with
3,724 securities.
The Fund seeks to achieve its objective by investing all of its assets in
Merrill Lynch Aggregate Bond Index Series. As of September 30, 1999, the Series
was comprised of 212 positions that possessed similar characteristics to the
Index. Investments in the three sectors were 39 securities in US Government and
agency issues, 38 securities in US Government agency MBS and 135 securities in
investment-grade corporate bonds.
Each of the three sectors within the Series is separately managed, although the
US Government and agency and corporate sectors are managed similarly. In these
two sectors, the Series seeks to neutralize duration. Duration is an indicator
of expected price volatility of a security (or group of securities) when
interest rates change. Therefore, if the duration of each sector is identical to
the corresponding sector in the Index, then the price movement of that sector in
the Series should match the price movement in the Index of that particular
sector. In addition, duration matching techniques are not complete until we
conduct an analysis of the duration exposure for each part of the yield curve
and match the distribution of the duration to ensure identical exposure.
Therefore, the Series applies neutral partial duration in addition to total
duration management to ensure tracking errors do not surface as a result of
changes in the shape of the yield curve.
In addition to duration matching, we employ other strategies to match the Series
to its index counterpart. It is critical that industry subsector exposure along
with credit rating neutrality are achieved in order for the tracking error to
remain at a minimum level.
Unlike the US Government and agency and corporate sectors, which have
well-defined maturities and therefore absolute durations, the MBS sector of the
Series is subject to prepayments, which impact duration. Since analysis can be
done to estimate future prepayments, the duration can be calculated assuming
these projected prepayments. However, since an uncertainty of prepayments
exists, there also is an uncertainty of duration. Accordingly, rather than
managing the MBS sector using duration neutrality, we manage this sector of the
Series by matching product, which entails having neutral exposure to coupon
(5.5%-11%), mortgage original term (30-year, 15-year and balloon) and agency
issues.
Merrill Lynch International Index Fund
For the three months ended September 30, 1999, Merrill Lynch International Index
Fund's Class A and Class D Shares had total returns of +5.51% and +5.35%,
respectively. This compares to the Fund's benchmark, the unmanaged Morgan
Stanley Capital International Europe, Australasia and Far East (MSCI EAFE) Gross
Domestic Product (GDP) Weighted Index, which produced a total return of +5.49%
in US dollar terms for the quarter ended September 30, 1999. (References to
securities markets of all regions/countries in this letter to shareholders
correspond to those countries' market weightings in the MSCI EAFE Index and are
in US dollars unless otherwise noted.)
Returns posted by international equity markets were mixed during the third
quarter of 1999, as the Pacific Rim component of the MSCI EAFE Index posted an
advance of 0.67% (in local currency terms), while the European component
declined by 2.41% (also in local currency terms) in the same period. However,
weakness in the US dollar relative to the Japanese yen resulted in a gain of
11.43% for the Pacific Rim component. A more moderate decline in the US dollar's
value against the euro resulted in the MSCI Europe Index's total return of
+1.17% for the September quarter. As a result, the third quarter of 1999 became
the fourth straight quarter in which there was a greater return contribution
from the Pacific Rim region than from Europe.
The GDP Weighted MSCI EAFE Index was led in the third quarter by double-digit
returns in Japan (+15.84%), Norway (+10.84%), and Denmark (+10.60%). The
worst-performing countries during the third quarter were New Zealand (-7.23%),
followed by Hong Kong (-6.23%) and Australia (-5.34%).
Merrill Lynch International Index Fund invests all of its assets in Merrill
Lynch International Index Series, which has the same investment objective as the
Fund. There are two principal investments made by the Series in its attempt to
replicate the returns of the Index. First, the Series holds a basket of stocks
designed to replicate the returns of the Index, with share quantities designed
to closely approximate each country's actual weight in the Index. In addition,
the Series maintains positions in several foreign futures contracts, which are
available in most of the major foreign markets in the MSCI EAFE Index. These
futures contracts provide an efficient mechanism for maintaining equity exposure
while also keeping a pool of liquidity available to meet potential Fund
redemption activity. As of September 30, 1999, the Series' equity portfolio was
valued at $146.8 million, and the Series' foreign futures contracts were valued
at $4.7 million. It is the Series' goal to be as close as possible to 100%
invested at all times. The Fund's net assets stood at $103.8 million on
September 30, 1999.
Merrill Lynch S&P 500 Index Fund
The second quarter of 1999 ended with the equity market rallying strongly,
leading up to the Federal Reserve Board's modest increase of 25 basis points
(0.25%) in the Federal Funds rate on June 30, 1999. At that meeting, the Federal
Reserve Board also shifted to a neutral bias regarding further interest rate
changes. As a result there was a late-month rally, with the Standard & Poor's
500 Composite (S&P 500) Index finishing the first half of 1999 at a record high
of 1372.71. The rally continued into the first half of July, as the S&P 500
Index reached yet another all-time high of 1418.78 on July 16. However, in the
second half of July, investors began to display concerns regarding increasing
oil prices and potential inflationary pressures in the economy, as well as the
possibility of several more rounds of interest rate increases by the Federal
Reserve Board. These jitters led to a sharp retrenchment in the equity market,
and the S&P 500 Index fell back to 1328.72 by the end of July, a 90-point drop
off of the highs established just two weeks earlier. For the month of July, the
S&P 500 Index produced a total return of -3.12%.
Despite the ongoing advances of large-capitalization stocks and the technology
sector in particular, the S&P 500 Index showed a modest decline during August,
posting a total return of -0.49% for the month. At the end of August, the
Federal Reserve Board raised short-term interest rates for a second time in
1999, but the increase was widely anticipated and had little effect on equity
market performance. In the face of rising long-term and short-term interest
rates, as well as concerns over the sharply higher price of oil, the market
remained choppy
2 & 3
<PAGE>
Merrill Lynch Index Funds, Inc., September 30, 1999
throughout the month of September. Lack of conviction in the equity market led
to a total return of -2.74% for September, and led the S&P 500 Index to fall
back through the 1300 level, which it had first broken through in the middle of
March.
For the third quarter as a whole, strong results within the technology and
energy sectors could not overcome broad-based weakness in most other sectors.
Large-capitalization stocks were the best performers once again, and while the
technology sector outperformed the S&P 500 Index by 11% and energy outperformed
the Index by 4.5%, the overall Index could not gather any momentum, resulting in
a total return of -6.24% for the third quarter of 1999.
For the quarter ended September 30, 1999, Merrill Lynch S&P 500 Index Fund's
Class A and Class D Shares had total returns of -6.30% and -6.37%, respectively.
Since inception (April 3, 1997) to September 30, 1999, the Fund's Class A and
Class D Shares provided total returns of +76.08% and +75.00%, respectively.
These returns compare to the unmanaged S&P 500 Index, which had total returns of
- -6.24% for the quarter ended September 30, 1999 and +77.52% from April 3, 1997
to September 30, 1999.
The Fund invests all of its assets in Merrill Lynch S&P 500 Index Series, which
has the same investment objective as the Fund. The principal investments of the
Series are a fully replicating portfolio of all 500 stocks in the Index and a
long position in S&P 500 futures contracts, which are used to quickly convert
most daily cash flows into the Series into equity exposure. At the end of
September, the Series' equity portfolio was valued at $1.4 billion. In addition,
the Series held a long position in futures contracts. As always, it is the
Series' goal to be 100% invested in the S&P 500 Index at all times.
During the quarter ended September 30, 1999, composition change activity
continued at a brisk pace. As a result, the Series added to its portfolio the
stocks of: Vulcan Materials, QUALCOMM Inc., ADC Telecommunications, Allied Waste
Industries, Conoco Inc., Lexmark International Group A, Tosco Corp., Global
Crossing Ltd., Bed Bath & Beyond and Adaptec Inc.
Merrill Lynch Small Cap Index Fund
For the quarter ended September 30, 1999, Merrill Lynch Small Cap Index Fund's
Class A and Class D Shares had total returns of -6.18% and -6.28%, respectively.
Since inception (April 9, 1997), the Fund's Class A and Class D Shares provided
total returns of +25.44% and +24.56%, respectively. These returns compare to the
unmanaged Russell 2000 Index, which had total returns of -6.32% for the quarter
ended September 30, 1999 and +27.14% from April 9, 1997 to September 30, 1999.
The second quarter of 1999 witnessed a dramatic reversal for
small-capitalization stocks, coming off the dismal performance of the year's
first quarter. The unmanaged Russell 2000 Index rebounded strongly to post a
total return of +15.55% for the three months ended June 30, 1999. However, this
momentum could not be maintained during the year's third quarter, as interest
rate concerns combined with worries about earnings prospects for small cap
stocks, and the Index fell in each month during the third quarter. For the three
months ended September 30, 1999, the Russell 2000 Index finished at 427.30, a
level it had first attained more than two years earlier, and still more than 60
points below its all time high that was achieved in April 1998.
With the exception of energy and technology, every sector within the Russell
2000 Index produced negative results during the September quarter. The energy
sector, particularly integrated oil stocks, continued to be the Index's leading
sector for the year as a whole. Double-digit returns were posted year-to-date
through September 30, 1999 by the technology and utilities groups as well.
However, several groups posted double-digit negative returns, leading the
Russell 2000 Index to a total return of -6.32% for the September quarter.
In Conclusion
We appreciate your investment in Merrill Lynch Index Funds, Inc., and we look
forward to assisting you with your investment needs in the months and years
ahead.
Sincerely,
/s/ Terry K. Glenn
Terry K. Glenn
President
/s/ Christopher G. Ayoub
Christopher G. Ayoub
Senior Vice President and
Co-Portfolio Manager
Merrill Lynch Aggregate Bond Index Fund
/s/ Gregory Mark Maunz
Gregory Mark Maunz
Senior Vice President and
Co-Portfolio Manager
Merrill Lynch Aggregate Bond Index Fund
/s/ Jeffrey B. Hewson
Jeffrey B. Hewson
Vice President and
Co-Portfolio Manager
Merrill Lynch Aggregate Bond Index Fund
/s/ Eric S. Mitofsky
Eric S. Mitofsky
Senior Vice President and
Portfolio Manager
Merrill Lynch International
Index Fund
Merrill Lynch S&P 500 Index Fund
Merrill Lynch Small Cap Index Fund
October 28, 1999
4 & 5
<PAGE>
Merrill Lynch Index Funds, Inc., September 30, 1999
PERFORMANCE DATA
About Fund Performance
Investors are able to purchase shares of the Fund through the Merrill
Lynch Select Pricing(SM) System, which offers two pricing alternatives:
o Class A Shares do not incur a maximum initial sales charge (front-end
load) or deferred sales charge and bear no ongoing distribution or account
maintenance fees. Class A Shares are available only to eligible investors.
o Class D Shares do not incur a maximum initial sales charge or deferred
sales charge and bear no ongoing distribution fee. In addition, Class D
Shares are subject to an ongoing account maintenance fee of 0.25%.
None of the past results shown should be considered a representation of
future performance. Figures shown in the "Recent Performance Results" and
"Average Annual Total Return" tables assume reinvestment of all dividends
and capital gains distributions at net asset value on the pay able or
ex-dividend date. Investment return and principal value of shares will
fluctuate so that shares, when redeemed, may be worth more or less than
their original cost. Dividends paid to each class of shares will vary
because of the different levels of account maintenance, distribution and
transfer agency fees applicable to each class, which are deducted from the
income available to be paid to shareholders.
Aggregate Bond Index Fund
Recent Performance Results
<TABLE>
<CAPTION>
3 Month 12 Month Since Inception Standardized
As of September 30, 1999 Total Return Total Return Total Return 30-Day Yield
===========================================================================================================
<S> <C> <C> <C> <C>
ML Aggregate Bond Index Fund Class A Shares* +0.77% -0.73% +17.61% 6.31%
- -----------------------------------------------------------------------------------------------------------
ML Aggregate Bond Index Fund Class D Shares* +0.61 -0.98 +16.89 6.06
- -----------------------------------------------------------------------------------------------------------
Lehman Brothers Aggregate Bond Index** +0.68 -0.37 +18.60 --
===========================================================================================================
</TABLE>
* Total investment returns are based on changes in net asset values for the
periods shown, and assume reinvestment of all dividends and capital gains
distributions at net asset value on the payable date. The Fund commenced
operations on 4/03/97.
** This unmanaged market-weighted Index is comprised of investment-grade
corporate bonds (rated BBB or better), mortgages and US Treasury and
Government agency issues with at least one year to maturity. Since
inception total return is from 4/03/97.
International Index Fund
Recent Performance Results
<TABLE>
<CAPTION>
3 Month 12 Month Since Inception
As of September 30, 1999 Total Return Total Return Total Return
==========================================================================================
<S> <C> <C> <C>
ML International Index Fund Class A Shares* +5.51% +34.59% +51.77%
- ------------------------------------------------------------------------------------------
ML International Index Fund Class D Shares* +5.35 +34.13 +50.80
- ------------------------------------------------------------------------------------------
MSCI EAFE Index--GDP Weighted** +5.49 +35.51 +48.72
==========================================================================================
</TABLE>
* Total investment returns are based on changes in net asset values for the
periods shown, and assume reinvestment of all dividends and capital gains
distributions at net asset value on the ex-dividend date. The Fund
commenced operations on 4/09/97.
** This unmanaged gross domestic product-weighted Index is comprised of
equity securities of companies from various industrial sectors whose
primary trading markets are located outside the United States and which
are selected from among the larger-capitalization companies in such
markets. Since inception total return is from 4/30/97.
S&P 500 Index Fund
Recent Performance Results
<TABLE>
<CAPTION>
3 Month 12 Month Since Inception
As of September 30, 1999 Total Return Total Return Total Return
==========================================================================================
<S> <C> <C> <C>
ML S&P 500 Index Fund Class A Shares* -6.30% +27.40% +76.08%
- -----------------------------------------------------------------------------------------
ML S&P 500 Index Fund Class D Shares* -6.37 +27.07 +75.00
- -----------------------------------------------------------------------------------------
S&P 500 Index** -6.24 +27.80 +77.52
==========================================================================================
</TABLE>
* Total investment returns are based on changes in net asset value for the
periods shown, and assume reinvestment of all dividends and capital gains
distributions at net asset value on the ex-dividend date. The Fund
commenced operations on 4/03/97.
** This unmanaged broad-based Index is comprised of common stocks. Since
inception total return is from 4/03/97.
Small Cap Index Fund
Recent Performance Results
<TABLE>
<CAPTION>
3 Month 12 Month Since Inception
As of September 30, 1999 Total Return Total Return Total Return
==========================================================================================
<S> <C> <C> <C>
ML Small Cap Index Fund Class A Shares* -6.18% +18.30% +25.44%
- ------------------------------------------------------------------------------------------
ML Small Cap Index Fund Class D Shares* -6.28 +17.86 +24.56
- ------------------------------------------------------------------------------------------
Russell 2000 Index** -6.32 +19.07 +27.14
==========================================================================================
</TABLE>
* Total investment returns are based on changes in net asset value for the
periods shown, and assume reinvestment of all dividends and capital gains
distributions at net asset value on the ex-dividend date. The Fund
commenced operations on 4/09/97.
** This unmanaged Index is comprised of approximately 2,000
smaller-capitalization common stocks from various industrial sectors.
Since inception total return is from 4/09/97.
Aggregate Bond Index Fund
Average Annual Total Return
% Return
===============================================================================
Class A Shares
===============================================================================
Year Ended 9/30/99 -0.73%
- -------------------------------------------------------------------------------
Inception (4/03/97) through 9/30/99 +6.72
- -------------------------------------------------------------------------------
% Return
===============================================================================
Class D Shares
===============================================================================
Year Ended 9/30/99 -0.98%
- -------------------------------------------------------------------------------
Inception (4/03/97) through 9/30/99 +6.46
- -------------------------------------------------------------------------------
International Index Fund
Average Annual Total Return
% Return
===============================================================================
Class A Shares
===============================================================================
Year Ended 9/30/99 +34.59%
- -------------------------------------------------------------------------------
Inception (4/09/97) through 9/30/99 +18.35
- -------------------------------------------------------------------------------
% Return
===============================================================================
Class D Shares
===============================================================================
Year Ended 9/30/99 +34.13%
- -------------------------------------------------------------------------------
Inception (4/09/97) through 9/30/99 +18.04
- -------------------------------------------------------------------------------
S&P 500 Index Fund
Average Annual Total Return
% Return
===============================================================================
Class A Shares
===============================================================================
Year Ended 9/30/99 +27.40%
- -------------------------------------------------------------------------------
Inception (4/03/97) through 9/30/99 +25.47
- -------------------------------------------------------------------------------
% Return
===============================================================================
Class D Shares
===============================================================================
Year Ended 9/30/99 +27.07%
- -------------------------------------------------------------------------------
Inception (4/03/97) through 9/30/99 +25.16
- -------------------------------------------------------------------------------
Small Cap Index Fund
Average Annual Total Return
% Return
===============================================================================
Class A Shares
===============================================================================
Year Ended 9/30/99 +18.30%
- -------------------------------------------------------------------------------
Inception (4/09/97) through 9/30/99 + 9.58
- -------------------------------------------------------------------------------
% Return
===============================================================================
Class D Shares
===============================================================================
Year Ended 9/30/99 +17.86%
- -------------------------------------------------------------------------------
Inception (4/09/97) through 9/30/99 + 9.27
- -------------------------------------------------------------------------------
6 & 7
<PAGE>
This report is not authorized for use as an offer of sale or a solicitation of
an offer to buy shares of the Funds unless accompanied or preceded by the Funds'
current prospectus. Past performance results shown in this report should not be
considered a representation of future performance. Investment return and
principal value of shares will fluctuate so that shares, when redeemed, may be
worth more or less than their original cost. Statements and other information
herein are as dated and are subject to change.
Merrill Lynch
Index Funds, Inc.
Box 9011
Princeton, NJ
08543-9011 Index Q--9/99
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