Professional stock pickers who feasted on last year’s volatility were positioned for more of the same heading into 2023. They got something else entirely, and are paying for it in their returns.
Only one in three actively managed mutual funds was ahead of equity benchmarks during the first quarter, the worst performance since the end of 2020, data compiled by Bank of America Corp. show. That contrasts with a hit rate of 47% in 2022 that was the best in five years.
Most active funds suffered as their tilt toward banks backfired following the collapse of multiple regional lenders and the pool of winning stocks shrunk amid an increasingly top-heavy market. Adding to the misfortune was a cautious positioning that proved ill-timed for a surprise equity advance.
“Sentiment was bearish heading into the year, leaving active funds potentially caught off guard by the market rally,” BofA strategists including Savita Subramanian wrote in a note.
Cash has become one of Wall Street’s favored hedging tools after 2022’s bear market. In the latest Bank of America Corp. survey of money managers, cash levels held above 5% for 15 straight months, the longest run since 2002.
While cash yielding 5% a year is not trivial, it fell short of the 7% gain in the first quarter from the benchmark S&P 500.
To be sure, even the most successful stock pickers trail the market from time to time, and all the caution may end up being prescient given the ominous backdrop facing risky assets, from monetary tightening to earnings downgrades and elevated equity valuations.
Yet the lousy start for active management is a departure from last year, when stock pickers managed to shine during the market selloff. Any further underperformance would weaken their position in an uphill battle against the rise of passive investing.
Adding to the pain were wrong-footed industry wagers. At the start of the quarter, large-cap core funds favored financial shares more than any other major groups except for industrials, according to Goldman Sachs Group Inc. data. Technology, on the other hand, was the least popular.
The actual sector performance turned out to be almost the exact opposite. Financial shares ranked at the bottom of the 11 S&P 500 industries, losing 6%, as bank failures spurred concern over the industry’s health. Meanwhile, money sought safety in cash-rich companies, sparking a 21% surge in tech.
All told, a Goldman basket of mutual funds’ most-favored stocks trailed their least-favored by 7.5 percentage points during the first quarter.
“Mutual funds materially underperformed recently due to their overweight in financials and underweight allocation to mega-cap tech,” Goldman strategists including David Kostin wrote in a note in late March.
The list of market-beating stocks that money managers can choose from is dwindling. This year, only 33% of members in the Russell 3000 have outperformed, compared with 47% in 2022. And many of the big winners are concentrated in one industry: tech.
To see the challenge facing stock pickers, consider this statistics: while the Russell 3000 was up 6.7% in the first quarter, the tech-heavy Nasdaq 100 surged 20%. That’s the widest spread in favor of the latter since 2001.
“Narrow breadth was a headwind for active funds,” said BofA’s Subramanian.
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