What happened to active management this year?
The idea behind active management seems sound: hire experts to help you navigate the treacherous waters of the stock market and profit from their experience and know-how. Most people do this via mutual funds—a pooled investment account where small investors can hire a big money manager.
But there’s an issue here. It’s called the principal-agency problem. The manager’s interests and the investor’s interests may not align. Investors want performance. Big managers need to look good. They can do this by outperforming their bogies or by massaging their numbers—or both.
But beating the market is hard: there are only two ways: time it just right, or pick winning stocks. Timing was particularly difficult in this year’s steady, up-trending market. And stock-picking has also been rough—over half the year’s move is from just 10 stocks—Apple and Microsoft prominent among them. Because these mega-caps have rallied so much, if managers didn’t overweight them—a gutsy call—they had a big performance hole to fill. And what they usually use to augment returns, selected small-cap and international shares, has been a drag on performance.
As a result, over 90% of mutual funds have underperformed the S&P 500 this year. That doesn’t mean active management is broken—people still need help. But it does mean that this was an especially tough time for them to beat their bogies.
It’s hard to discern the signal from the noise with short-term numbers—so much changes from year to year. What’s most important is if the manager is helping you meet your goals. That, and integrity. That’s a performance factor that can’t be faked.
Douglas R. Tengdin, CFA
Chief Investment Officer
Leave a comment if you have any questions—I read them all!