The market rally is delivering tough lessons for fund managers
Oh, poor fund managers. Why the long faces?
July was great! The S&P 500 delivered its best performance since late 2020, rallying 9%. It was one of the best months on the market ever. Of course, the withdrawal of largesse from the world’s most important central banks introduces a new wave of asset price volatility, but this has to be the rebound we’ve all been waiting for, right?
Apparently not. Instead, it seems like yet another painful trade. Bank of America notes that despite last month’s super meteoric rally, only 28% of active fund managers focusing on big stocks beat their Russell 1000 benchmarks. All major mutual fund styles underperformed — heart, growth and value.
Kudos to the minority, but how did everyone pull this off? All year, investors are desperate for a break from the clouds, and finally the hint of a little leniency from the Fed arrives, and they are still behind their benchmarks. It seems that too much money has been tied up in the hidden money hole and too little has been deployed in the recovery.
A bearish stance “likely weighed on performance,” BofA analyst Savita Subramanian and colleagues said in a note to clients. Opportunities to beat the market are still rare, she added, making it a “challenging environment” for funds that pick stocks rather than piggyback on indices.
One explanation for this is that professional investors are not fooled. This hint of leniency from the world’s most powerful central bank was hugely over-interpreted and came with far more caveats than the initial market reaction suggested.
All Fed Chairman Jay Powell said was that it would probably, but not definitely, be appropriate to slow the pace of interest rate hikes going forward. Some market participants took this as a signal to increase bets on rate cuts and pull back on stocks that have suffered as the Fed spoke toughly on inflation. This week, a series of Fed speakers told the markets to calm down. They are not yet close to a pivot point and expectations of rate cuts next year are premature, they said.
Another way to think about this is to ask who was making the purchase. Much of it seems to come from extremely bearish funds, with plenty of shorts – or bets against stocks – on their books. Hedge funds and momentum hunters such as commodity trading advisers – CTAs – had largely retreated on risky assets, then rushed to catch up when stocks rose, a practice known as hedging. short.
“The rebound in equity. . . in July was mainly due to short hedging,” Barclays analysts wrote. “Best-selling stocks have indeed outperformed in Europe and the US.”
An equally weighted basket of the 50 most shorted stocks in the Russell 3000, “led by the most speculative. . . non-profit names,” has climbed some 31% since June, says Neil Campling, equity analyst at Mirabaud, with Europe now catching up.
Anik Sen, head of stocks at PineBridge Investments, is what you would call a bottom-up investor, building portfolios focusing on a relatively small number of stocks – 30 to 40. His mission is to select the right stocks and neutralize the effect of broader movements in the indices. This task, he says, is increasingly complicated by the oversized role played by stock flows from macro funds and CTAs.
“I’ve been doing this for over 35 years, almost 40 years. The disconnect between bottom-up and top-down is perhaps the widest I’ve ever seen,” he says. “The markets are not moved by you and me, but by the macro traders. . .[Their flows]dwarf those of fundamental investors.
It goes both ways. Sen believes July’s rally is “sustainable” and that markets have been too sluggish for much of this year. Some company stories are much stronger than investors give them credit for, he believes. “We can’t understand why the markets are so negative,” he says, adding that the war in Ukraine, inflation, supply chain strains and China’s Covid shutdowns masked otherwise positive factors. .
But the lackluster performance of mutual funds in July underscores how broad asset allocation shifts tied to powerful macro trends are rail stocks pundits.
I feel after talking to fund managers that it becomes extremely frustrating. They were wrong to be so positive at the start of the year and then they missed a turn in July. The best approach now is probably to be somewhat philosophical.
“You can easily get caught up in short-term moves,” said Mamdouh Medhat, principal researcher at Dimensional Fund Advisors, the quantum house founded in the 1980s. ball.”
As boring as it sounds, staying true to the markets over the long term is almost always the best tactic. “It’s very, very difficult to beat the market by trying to guess it. People sometimes make the right calls out of sheer luck,” Medhat says with the soothing tone of a therapist. “Be stoic. . . If you’re broadly diversified, you get the only free lunch in finance,” he says.