Among all mutual funds that invest in big U.S. stocks like
those in the S&P 500, only 9.3% are beating the index through Sept. 30,
according to Denys Glushkov, a senior researcher at Wharton Research Data
Services at the University of Pennsylvania. Although the year isn’t over, that
is well under the previous annual low of 12.9% in 1995 and the average of 38.6%
over the past quarter-century. Data through Oct. 31 from Lipper, a
fund-research firm, show results nearly as dismal.
Before deciding what to do, it helps to know what is causing
active managers to underperform so poorly. Portfolio managers and industry
analysts say several forces are at work—and most of them are probably
The average U.S. stock fund has 5% of its assets in non-U.S.
stocks, according to Chicago-based investment researcher Morningstar. Markets
in the rest of the world have trailed the U.S. by 14 percentage points so far
this year. The S&P 500 has no holdings listed primarily on foreign
exchanges but active U.S. stock funds do, and that alone accounts for about 0.7
percentage point of underperformance.
So far this year, the Russell 2000 index of small stocks is
up 3.1%, including dividends, while the S&P 500 is up 13.9%—the widest gap
in favor of large stocks since 1998. The returns for various industrial sectors
have been fluttering around like poultry on the run. Last year, energy stocks
were up 22.3% and utilities up 9%, according to S&P Dow Jones Indices. But
with oil prices and interest rates falling in 2014, energy stocks had lost 3%
even before they collapsed at the end of this past week, while utilities have
Another factor: the one-year average of a technical measure
called “dispersion”—which tracks the difference between the returns of winning
and losing stocks—is at its lowest levels in modern history.
If the best stocks don’t perform much better than the worst,
it’s hard for stock pickers to distinguish themselves. If the S&P 500 keeps
soaring like an eagle over the heads of most stock pickers, even the true
believers in active management would have a hard time maintaining their belief.
If stock pickers’ bad performance persists for, say, two more years, you’d have
a huge reduction in the money allocated to active managers.
But low dispersion is driven largely by the market’s lack of
sharp swings this year—which, in turn, appears to be fueled by low interest
rates. Meanwhile, index-fund investors
shouldn’t get cocky about the margin by which they have beaten investors in
actively managed funds. If small stocks outperform large ones, international
stocks beat the U.S., and volatility revisits the market, active managers will
regain some of the ground they have lost. And in the long run it can be easier
for some investors to stick with a charismatic stock picker than with a
faceless index fund.
Of course, most stock pickers are still likely to
underperform a comparable index fund over time. But they aren’t going to look
quite this bad all the time.
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