Why did active fund managers do a bad job picking stocks this year?

Wall Street strategists have crunched a lot of numbers recently in an effort to answer a simple question: Why have active fund managers done such a lousy job picking stocks this year?

Wall Street strategists have crunched a lot of numbers recently in an effort to answer a simple question: Why did active fund managers do such a lousy job picking stocks this year?
Depending on how you tally returns, it looks like three quarters or more of active funds are trailing their benchmark indexes this year. Bank of America Corp. strategist Savita Subramanian recently put the number of outperforming funds at only 18%, the lowest “hit rate” in 10 years. Meanwhile Vanguard Group Inc., whose motto could be “if you can’t beat benchmarks, join ’em,” is attracting record new investments into strategies that track indexes passively at a much lower cost than active funds.
Here are some of the most-common excuses cited for what Arthur Miller might call “Death of a Stock Picker”: the Federal Reserve’s spigot of liquidity led to tighter correlations and less dispersion among industry groups that made it difficult to identify potential outperformers. And the boom in exchange-traded funds is also credited with having a similar effect.
Tom Lee of FundStrat Global Advisors contributed another handy excuse: blame Apple Inc. Or rather, blame yourself if you didn’t load up on Apple shares. Apple, the largest company in the world, has rallied 41% this year, about four times as much as the Standard & Poor’s 500 Index. Last year, the shares were only good for about a fifth of the S&P 500’s 30% gain.
APPLE EFFECT
Not owning Apple in 2014 was one of the biggest reasons managers trailed benchmarks this year, according to Mr. Lee, accounting for 81.3 basis points of an average 340 basis-point underperformance. Skipping Microsoft Corp. (MSFT), up 33% in 2014, was good for another 36.2 basis points in underperformance, according to Mr. Lee.
And while many fund managers are cursing this year’s 18% rally in utilities, Mr. Lee points out that the group only accounts for 3% of the S&P 500 so the absence of the entire industry in a fund would only be good for 25 basis points of underperformance.
The good news for next year may be that Mr. Lee and other strategists believe active stock funds could be primed for a comeback.
”Era of Active Investing Upon us,” is how Brian Belski, chief investment strategist at BMO Capital Markets, titled a report in September. He pointed out that intra-stock correlations, or the tendency of stocks to rise or fall together, have dropped in recent months and are now at below-average levels after many years above.
‘THE KEY’
“More active stock-picking strategies will be the key to delivering outperformance over the coming months and years, as opposed to the more passive strategies that have mostly dominated investing trends since 2013,” he wrote.
The low amount of return dispersion among industry groups may be only partly attributable to the rise in popularity of ETFs, according to Mr. Lee. A better explanation may be that dispersion is cyclical and instances of unusually tight returns eventually revert back to the long-term average, Mr. Lee wrote, which would provide a boost to the performance of actively managed funds.
Of course, the cynics among us may point out that active fund managers are sort of the key consumers of equity research, so it’s possible no one is rooting for the recovery of stock picking more than the folks who are paid to come up with stock-picking ideas.
So cynics, feel free to ignore these long ideas that Mr. Lee said should benefit from an increase in dispersion (but bet you can’t!): Delta Air Lines Inc., Intercontinental Exchange Inc. and Skyworks Solutions Inc., among others.
And finally: keep that dog away from your alpha.