Rather than being bitter at index funds, they say they look for
mispricings
By Simon Constable
This article is being republished as part of our daily
reproduction of WSJ.com articles that also appeared in the U.S.
print edition of The Wall Street Journal (May 7, 2018).
Since the financial crisis there has been a consistent mantra
around investing: Low-cost index funds makes the most sense because
they are generally cheaper and perform better over long periods
than mutual funds managed by stock pickers.
But now, some active managers are taking a new tack in making
the case for their approach: They say the popularity of indexing,
along with other changes in the market, is making it easier for
them to find mispriced securities, resulting in a more fertile
environment for stock picking than they've had in years.
"When markets [were] moving up like a rocket ship, it paid to
have the cheapest exposure," says Joe Amato, chief investment
officer at money-management company Neuberger Berman, acknowledging
that in recent years the investing planets were aligned better for
passive low-cost funds. During that period, the easy availability
of credit ushered in by the Federal Reserve meant that many highly
indebted companies could stay in business, he says. Buying
high-quality companies didn't matter as much, and there was little
price dispersion between individual stocks, he adds.
Then things changed. The Fed started to unwind its bond-buying
program and began raising the benchmark federal-funds rate. The
interest rate on the 10-year Treasury note has jumped.
Amid higher borrowing costs, price differences between lagging
stocks and the top-performing ones have widened, Mr. Amato says,
creating more opportunities for portfolio managers to find
bargains.
Bargains to be had
Although it has been five years since even half of actively
managed U.S. stock funds outperformed their benchmarks, their
performance is improving. According to data from Morningstar Inc.,
53% of such funds beat their benchmarks in the first four months of
this year, up from 49% last year and 29% in 2016.
And while investors continued to pull money from actively
managed U.S. stock funds in the 12 months through February, the
outflows slowed by 15% compared with the year-earlier period, the
Morningstar data show.
More active managers are beating their benchmarks; typically it
is done by veering outside the index, says Ben Johnson, director of
global ETF research at Morningstar.
Other money managers agree there are more bargains to be had
now, especially among smaller stocks that aren't included in the
major indexes tracked by large ETFs. Last year, 63% of active
small-cap growth funds and 54% of active small-cap value funds beat
their benchmarks, up from 29% and 18%, respectively, in 2016,
according to Morningstar data.
"The money that goes into the passive indexes tends to gravitate
toward the S&P 500," says George Young, a portfolio manager at
Villere Balanced Fund in New Orleans.
SPDR S&P 500 ETF, for example, is the largest and most
actively traded security in the world. The result is that large-cap
stocks get bid up in price because of the massive flows into such
ETFs, while smaller stocks often stay cheaper, Mr. Young says.
"We own Howard Hughes [Corp.]," he says. The $5 billion
real-estate firm trades at less than twice book value, he says,
compared with 13 times book value for the $50 billion Simon
Property Group Inc.
Skepticism remains
Of course, plenty of experts aren't buying the argument that
stock pickers are making.
"I hear people say that now is a good time for active
management, but I believe it is becoming extinct," says Mitch
Tuchman, managing director at Rebalance IRA in Palo Alto, Calif.
Compared with the stock-picking heyday before the 2007-09
recession, it is now devilishly tricky to succeed in active fund
management, he says.
"Today when you find something mispriced, others find out the
same things very quickly," he says. "The time frames are
shortened," in part due to technology. The speed of the market
means managers often don't have long enough to build positions of
sufficient size to make a meaningful difference in their fund's
performance, he says.
Still, Mr. Amato says bets on mispriced securities have paid off
for his firm in recent years, including one on Goldman Sachs Group
in 2016. Goldman shares had slumped around 20% in June 2016 after a
decline in commodities prices to a multiyear low earlier in the
year dragged down stocks and bonds.
"We saw an outstanding team, with the willingness to right-size
the operation," says Mr. Amato. "We also had confidence in their
investment-banking franchise." In short, he says his team thought
the bank would eventually out-compete its second-tier competitors.
As of May 1, the stock had rebounded around 70% from its June 2016
low.
Similarly, Craig Hodges, chief investment officer at the Hodges
Funds, says his firm took advantage when a drop in oil prices a few
years ago crushed shares of United Rentals, which in addition to
serving industrial customers also provides equipment to
petrochemical businesses. During the oil-price rout, the price of
the stock fell by more than half, "yet earnings estimates hardly
moved," Mr. Hodges says. "The energy bust didn't fundamentally hurt
their business."
Since early 2016, the stock has more than tripled.
Mr. Constable is a writer in Edinburgh, Scotland. He can be
reached at reports@wsj.com.
(END) Dow Jones Newswires
May 07, 2018 02:47 ET (06:47 GMT)
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