The most contrarian move in investing: Trusting a stock picker
NEW YORK (AP) — It’s perhaps the most contrarian move in investing today: Trust a stock picker.
Investors have been dumping funds run by managers who try to beat the market, and they’re pouring money instead into those that track the Standard & Poor’s 500 or other indexes. Last month alone, $44 billion left actively managed stock funds, and nearly $41 billion went into comparable index funds.
To understand why, have a look at the mutual fund scorecard. Index funds have generally done better than actively managed ones over the last one, five and 10 years. Among mutual funds that invest in a mix of large-cap stocks, just 15 percent of actively managed funds managed to beat index funds over the decade through June 2016, according to Morningstar.
It’s not just stock pickers catering to mom-and-pop investors who are struggling. Hedge funds, which invest for the uber-wealthy and big institutions, have also been lagging behind index funds. Through July, they were on pace for a third straight year of lower returns than either an S&P 500 index fund or an investment that tracks a Barclays bond index, according to industry researcher HFR Inc.
But what if you can’t stand the idea of being just average? Some investors are confident they can pick the active manager who will beat the market. Other, more skittish investors would like the comfort of having a manager who can limit losses when market indexes are tumbling.
That’s why some actively managed funds are still pulling in money. American Funds, which is the second-largest fund family by assets, is unabashedly in favor of active management. It attracted a net $5 billion in investment in the first seven months of this year, though the pace has cooled recently.
Even the biggest index-fund provider, Vanguard, has actively managed funds of its own, and they’ve been drawing dollars too.
Two important factors can help determine whether an actively managed fund will beat the market.
Number one is fees. Lower-cost actively managed funds have a better track record of success than expensive ones. It’s for the simple reason that a high-fee fund needs to perform that much better to match the returns of a low-cost fund. Index funds have some of the lowest fees available.
After splitting large-cap blend funds into four categories based on their fees, Morningstar found that 19 percent of the cheapest funds beat index funds over the last decade. That may not sound like much, but it’s way better than the 8 percent success rate for the highest-cost funds.
The trend carries through across different categories of mutual funds and is most pronounced at funds that invest in stocks from China, India and other developing economies.
Stock pickers say these markets are particularly suited for them because they can avoid the large, state-owned companies that make up big chunks of those indexes.
Another consideration is to look for active funds where managers invest alongside their own shareholders. It’s a concept called “eating your own cooking,” and managers have to disclose in filings with the Securities and Exchange Commission data about how much they’ve invested in their own funds, if they do so at all.
American Funds says that stock funds with both low expenses and high manager ownership have much better track records than other actively managed funds.
After looking at rolling one-year returns over the two decades through 2015, it said this select group within large-cap U.S. stock funds had average returns of 10.1 percent, a shade higher than the S&P 500’s 9.8 percent. They also beat the index 55 percent of the time.
For their part, stock pickers acknowledge they’ve had a rough few years in comparison to index funds. But they say they’re anticipating better conditions ahead.
In recent years, stocks have often moved up and down in unison, making it harder to pick winners and losers.
That herding effect reduces the rewards for a stock picker looking to pick which, say, individual oil company looks best in the industry.
Stock pickers lay the blame for this, in part, on the massive amounts of stimulus coming from the Federal Reserve and other central banks.
The Fed’s next move now, though, is likely to raise rates, not lower them. If that helps break the market’s recent herd mentality, active managers say conditions may finally tilt more in their favor.