Alpha dogs as talent shortage looms for stock portfolios

Things could get a lot worse before they get better for long-only equity mutual funds. Beset by inconsistent performance and the growing popularity of indexing, the long-only stock funds have been shedding market share for years. Active equity funds held $4.4 trillion, or 34% of mutual fund market share, at the end of last month, down from $4.7 trillion and 42% of the market share at the end of 2007, according to Lipper Inc. “They still have a lot of assets, but in general, it's not a positive story,” said Brent Beardsley, a partner at the Boston Consulting Group, an asset management consultant. To make matters worse, their dwindling popularity is making it harder for mutual fund companies to attract top talent, he said. “The new talent isn't going to long-only stock funds. It's going into hedge funds,” Mr. Beardsley said. “Mutual fund companies are not getting the talent they're used to,” he said. “It's hurting the ability to generate alpha.” That is bad news for an industry that had a hard enough time generating alpha when stock mutual funds were cool. From 1999 to 2003, for example, more than half of large-cap funds underperformed the S&P 500, according to Standard and Poor's. From 2004 to 2008, less than 30% beat the index. Over the last five years, less than 25% outperformed. Although increased correlation among stocks is a popular theory for why active managers have failed to beat their benchmarks, a study by The Vanguard Group Inc. found that there is plenty of opportunity to produce alpha in the market, lending credence to the theory of a talent drought. More than half the stocks in the S&P 500, for example, finished with a return more than 10 percentage points different than the benchmark annually since 2000, according to Vanguard. That is at least 250 opportunities to overweight stocks that will outperform or underweight stocks that underperform the benchmark index. The average 1% or so fee that investors have to pay an actively managed fund doesn't help managers' performance either, but if there really is a talent problem, there might not be a fee small enough to push managers past their benchmark.