by Over the past 20 years, stock pickers have had a dismal track record. Most have not come close to beating the broader stock market.
But occasionally there are exceptions. In some periods, stock pickers rule, and the beginning of this year was one of those times.
In fact, it was the best January for actively managed stock mutual funds since Bank of America began collecting data in 1991. It wasn’t just that they generated attractive returns for investors. The entire stock market did that. The S&P 500 and other stock indexes set records during the month.
It was that active stock funds did even better, although not by much, outperforming various market indexes by less than a percentage point, on average. Still, it was the best month for these funds – in which managers buy and sell individual stocks as they wish – since 2007. That turned out to be the best calendar year for stock pickers in decades.
There is no way to know how long this streak of outperformance will last, or why, exactly, it has existed in the first place. But it’s entirely possible that it will continue for the rest of the year, and buying the average actively managed fund will look like a brilliant move. Index funds that mirror the entire market could well be left behind.
That said, I think active fund managers are unlikely to prevail in the long term. The reason is that history shows that it is too difficult to beat the market.
a random walk
To get a deeper perspective on market history, I called Burton Malkiel, the Princeton economist who in 1973 wrote “A Random Walk Down Wall Street.” The fifteenth edition of the book came out last year, its 50th anniversary.
“I wrote in that book that a blindfolded chimpanzee could pick stocks as well as experts,” he said, laughing. He explained that he had never intended to denigrate stock pickers. He just wanted to make it clear that while the stock market tends to go up in the long term, no one knows what it will do day to day. Therefore, it is futile for most people to try to outperform the broader market.
“The historical record shows that the idea is basically correct,” he said. This is likely to be true in the future as well, she added.
Professor Malkiel is now the chief investment officer of wealth front, an automated investment company that uses index funds and avoids stock picking. However, when he wrote “A Random Walk Down Wall Street,” there were no commercially available index funds; It would be three years before Jack Bogle of Vanguard started the first one. But Professor Malkiel, who later became a director at Vanguard, wrote at the time that index funds would become the essential form of investing and that stock picking could not prevail in the long term.
The market is too “efficient” for that, he told me. “That means the information is quickly reflected” in prices, she said. “This does not mean that prices are always ‘correct.’ They are not. They are constantly changing. But no one knows for sure whether prices are too high or too low, or where they are headed. There is no way to know for sure. There are too many things happening. And that’s why most active managers can’t do better over the long term than you can by investing in the entire market with an index fund.”
We spoke on Tuesday, shortly after the monthly Consumer Price Index report was more interesting than the market expected, and stock prices at the time were falling. “This kind of thing happens all the time,” Professor Malkiel said. “Who knows where the stock market will go from here? I don’t think you can know.”
People on Wall Street saw his view as absolute “heresy” when he started popularizing it, and it is still somewhat “controversial,” he said, because many managers continue to try to beat the market, and while it is difficult, some actually do..
“It is certainly possible to beat the market,” said Professor Malkiel. And there are certainly some periods, like January, when most active fund managers achieve this.
But the basic truth is that over periods of 10 years or more, about 90 percent of active managers have failed to outperform index funds, and those who have rarely repeated the feat for long.
A good streak in January
It’s hard to overstate how good January was for active managers.
No matter which primary benchmark Bank of America analysts used, active managers stood out.
Compared to the Russell 1000 index, which tracks the publicly traded stocks with the highest market value, 73 percent of actively managed large-cap stock mutual funds outperformed. They outperformed the index by an average of 0.57 percentage points. Similarly, 61 percent of actively managed stock funds outperformed the S&P 500.
The pattern also held for investments in smaller companies. Among actively managed funds compared to the small-cap Russell 2000, 86 percent outperformed the index. Against the Russell Midcap index, 64 percent of actively managed funds outperformed.
It’s unclear how the fund managers as a group did it, but there are some possible explanations.
In the case of large-cap stocks, Bank of America found that active managers generally deviated from their benchmarks by focusing on high-performing companies such as Microsoft and Meta, which rallied thanks to investor enthusiasm about the prospects for take advantage of artificial intelligence applications. The bank didn’t mention Nvidia, but the company, which makes chips that power AI, outperformed the broader market, and a bigger stake in its stock would push a fund ahead of indexes.
At the same time, some large-cap stock funds reduced their holdings of tesla and Apple, which fell in January in reaction to sales obstacles.
But the relative performance of these and other companies is likely to change, and when that happens, there’s no guarantee that active managers will get their stock picks right.
A little story
Since 2001, most active managers have not made the right decisions.
As I’ve noted, a long-running, detailed study of fund performance by S&P Dow Jones Indices shows that active managers have not outperformed the market. Until the middle of last year, active equity fund managers lagged the market:
93 percent of the time for 20 years.
90 percent of the time for 10 years.
73 percent of the time over five years.
72 percent of the time during a year.
Even when individual fund managers have outperformed indices, they have rarely done so repeatedly and consistently. As of June 2022, for example, no fund had finished in the top quarter of actively managed funds each year for five consecutive years.
One reason for this persistent failure is that actively managed funds generally have higher fees than passive index funds, and this hurts their performance.
However, actively managed funds have occasionally had streaks of outperformance. Since 2001, active managers have outperformed the S&P 500 in 2005, 2007 and 2009. In 2007, the best year for active managers, 45 percent outperformed the index.
“It definitely happens from time to time,” he said. Anu R. Ganti, senior director of index investment strategy at S&P Dow Jones Indices. “It’s too early to tell, but this could be one of those years. The thing is, based on probabilities, outperformance by active managers is not likely to occur for a long time.”
I will be watching the horse race between active managers and indexes closely, and I hope, personally, to settle for what the market averages bring. Beating the market is exciting if you can do it. Falling behind is much less fun and that, unfortunately, is what often happens to those who have tried to outwit the market.
