Stock pickers might as well wear a scarlet "A."
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"Active management" is becoming more of a taboo when it comes to mutual funds. Many investors are abandoning actively managed funds, wary of their high fees and recently disappointing performance. Instead, they're funneling money into lower-cost index funds, which aim to match the stock market's returns rather than beat them.
But stock pickers are still getting a chance in at least one area: Actively managed foreign-stock funds continue to attract billions of dollars in new investment. That, plus some other trends from around the mutual fund industry:
— INVESTORS ARE STICKING WITH (SOME) STOCK PICKERS.
For decades the standard approach was to find a good manager who could beat the market. Bill Miller, for example, became famous for guiding his fund at Legg Mason to better returns than the Standard & Poor's 500 index for 15 straight years.
But Miller's fund fell short of the index in 2006 and lagged in following years. It's a familiar trend for many stock pickers. Nearly 60 percent of large-cap stock funds did worse than the S&P 500 for the year ended in June, according to S&P Dow Jones Indices. The numbers are even worse over the longer term: In the last five years, 87 percent failed to keep up with the index.
The reaction for many investors was simple. They pulled their money. Over the last 12 months, they withdrew a net $92 billion from actively managed U.S. stock funds, according to Morningstar. That's despite a growing appetite for U.S. stocks. Over the same period, investors deposited $156 billion into funds that track the S&P 500 and other U.S. stock indexes.
For foreign stock funds, the numbers are different. Investors are still willing to pay for a manager to pick winning stocks. Actively managed foreign-stock funds attracted $68 billion over the last year. To be sure, that's only about three quarters of what their index-fund counterparts received. But it stands in stark contrast to the nine straight months of withdrawals from actively managed U.S. stock funds.
One reason for the difference is that many investors believe they have more opportunities to capitalize on mispriced stocks in foreign markets. In financial-ese, managers say that foreign markets are "less efficient."
Another possible reason: There can be a wide discrepancy among the performance of various foreign markets, which makes it even more worthwhile to stick with winners and avoid losers. The Nikkei 225 index fell in 13 of the 22 years from 1990 through 2011, for example. So simply avoiding Japanese stocks was a good way for global fund managers to beat their benchmark during that period.
The recent track record for actively managed foreign-stock funds, though, is spotty. Small-cap funds are a bright spot. More than half have beaten their relevant Standard & Poor's index for five-year returns.
But the majority of large-cap foreign stock funds have fallen short. Same with funds that focus on emerging-market stocks, which have a reputation for being less efficient.
— IT'S TOUGH FOR FUND MANGERS TO STAY ON TOP.
For all the criticism heaped upon fund managers, many beat their benchmark index. But once their funds get to the top, they rarely stay there, according to data from S&P Dow Jones Indices.
Consider the 251 funds that had a strong enough one-year record to finish in the top quartile of all large-cap funds at the end of September 2012. Less than a third repeated the feat the following year. And just one in 10 did it three years in a row.
Stretch the time period out by two more years, and the numbers become minuscule. Of the funds in the top quartile of large-cap funds at the end of September 2010, just 0.4 percent were there five years in a row.
— FUNDS FEAR EXXON MOBIL, LOVE EMC.
One pick that fund managers have gotten right this year is to avoid Exxon Mobil.
As the third-largest stock in the S&P 500, the oil giant's performance has a bigger effect on the index than any company outside Apple and Microsoft. This year, it's been a negative. Exxon Mobil has shed 11 percent of its value due to the plunge in the price of crude oil.
But many fund managers have shielded themselves from the slump. Fund managers who own a mix of value and growth large-cap stocks keep much less of their portfolios in Exxon Mobil than the S&P 500, according to a review by Goldman Sachs. In fact, it's the least-owned stock, relative to its weight in the index.
On the other side, technology company EMC is one of the most popular stocks, relative to its weight in the S&P 500. Its stock has jumped 18 percent this year, versus the index's 11 percent. That means fund managers have gotten a bigger boost from its rise than S&P 500 index funds.
So why are most fund managers struggling given those good calls? Many have also avoided Apple, one of the better stocks in the index this year.