Every Stock Picking Opportunity Is a Way to Lose Money Too
January 16 2017 - 12:25PM
Dow Jones News
By James Mackintosh
Stock picking is back.
After years of central banks lifting the entire market on a tide
of freshly minted money, Donald Trump's U.S. election victory has
already led to the biggest gap between winning and losing shares in
seven years. After Mr. Trump takes office on Friday, fresh policies
will "Make Active Great Again," says Goldman Sachs.
Investors who get their stock picks right should be able to beat
the market by more in the new environment.
The bad news: If they get it wrong they will lose more.
Unfortunately for fund managers, facing a more diverse market
"doesn't magically make people any more clever or lucky," said Tim
Edwards, senior director of index investment strategy at S&PDow
Jones Indices.
Measures of market diversity jumped to postcrisis highs after
the election. November had the biggest gap between the best and
worst performing S&P 500 sectors since April 2009, as bank
shares soared and utilities plunged. A formal measure of
dispersion, the asset-weighted standard deviation of stock returns,
was at its highest for seven years in November, Mr. Edwards
calculates.
The trend in recent years for share prices all to move together
has broken down. The correlation between members of the S&P 500
is now the lowest since the Great Recession began, according to
Bank of America Merrill Lynch calculations.
Mr. Trump inspired such big differences in share performance as
investors bet on renewed inflation and faster economic growth.
While market dispersion fell back in December as investor
excitement about Mr. Trump's election waned, the promise of new
tax, spending, trade and diplomatic policies suggest plenty of
scope for shares to swing in different directions in the year
ahead. Add in the Federal Reserve's retreat from easy money
policies and the dispersion between stocks which benefit or miss
out from the new policies should rise.
Unfortunately for buyers of mutual funds, there is scant
evidence that a more diverse market means the average fund manager
does any better, as those outperforming by more are counterbalanced
by those underperforming by more. But even given this, it is great
news for active fund management companies and their marketing
teams. So expect a lot more promotion of the fund managers who were
smart or lucky and came in well ahead of their benchmarks.
How should investors take advantage? Those confident either in
their own ability to pick stocks or their skill at selecting fund
managers, should be putting effort into selection again. That is
after years of focus on macroeconomic and political drivers. For
everyone else--and history suggests very few of us are consistently
good at choosing either good shares or good managers--the recent
trend of choosing low-fee passive funds is still the way to go.
Rising dispersion doesn't make life easier for the supposed
"smart money" managers of hedge funds, thanks to the same financial
logic.
Investors taken as a whole will perform in line with the market,
minus fees, since they are the market. For every fund manager
making $1 more than the index, someone else has to make $1 less.
Occasionally that someone is an insurance company, pension fund or
individual investor, but with fund managers making up the bulk of
equity trading, it is more likely to be another fund manager.
Outperformers are almost completely canceled out by
underperformers.
There are a couple of minor exceptions. First, higher dispersion
of stocks means the clever or lucky investors who outperform are
more likely to beat the market by enough to justify their fees,
which makes the funds run by the best managers rather more
appealing (if only they could reliably be identified in
advance!).
Second, because mutual-fund managers hold a permanent pool of
cash against redemptions, they tend to outperform in falling
markets. If the few remaining bears are proved right and the market
falls, that means the average manager will have more chance of
beating the market. Of course, those who expect a bear market will
have sold their funds, and in a falling market investors are more
likely to pull their money out anyway.
For investment businesses, rising dispersion could be good. Even
if active managers underperform on average, the basic business
model of flogging the funds which have done best works better when
there are some really good performers to promote. Needless to say,
there won't be any advertising featuring the funds that lost
out.
A cynical investor might think rising dispersion makes the
shares of active fund managers a better bet than their mutual
funds. Even here, though, the long-running trend downward in fees
as money switches to low-cost index trackers and exchange-trade
funds is unlikely to reverse quickly, keeping the business of
active fund management under pressure.
Write to James Mackintosh at James.Mackintosh@wsj.com
(END) Dow Jones Newswires
January 16, 2017 12:10 ET (17:10 GMT)
Copyright (c) 2017 Dow Jones & Company, Inc.