2016 - Yet Another Dismal Year for Active Management

Cheri Franklin |

The title of this CNBC article from 1/7/2017, “2016 Was a Terrible Year for Stock Picking, and 2017 May Not Get Much Better”, pretty much says it all. Of course, this is no surprise to those of us who follow the financial industry, as it seems to happen on a regular basis. So just how terrible was it? Only 19% of large-cap active managers beat the Russell 1000 index, according to Bank of America Merrill Lynch. The numbers were better (but still subpar) for mid-cap and small-cap managers at 46.3% and 35.6%, respectively. The average large cap fund delivered an 8.4% return compared to 9.7% for the Russell 1000 Index. The author (Jeff Cox) notes that this debacle occurred despite the favorable  movements of the two factors that allow active managers to distinguish themselves—correlations among stocks decreased while the dispersion of returns increased in 2016.

Given that small cap stocks outperformed large caps in 2016, we might have expected a better showing from large cap managers who may have drifted into small caps. However, this was not the case due to underweighting of 2016’s best-performing sectors (energy, financials and telecom)  and overweighting of the worst-performing sector (health care), according to Savita Subramanian, equity and quant strategist at BoAML. Of course, if they had been market-weighted in all the sectors, they still would have underperformed due to the higher costs of active management. Subramanian also provides a retort to the “Wall Street Pros” who are predicting 2017 to be a “breakthrough year” for stock pickers due to opportunities presented by volatility and tightening Federal Reserve policy: “Moreover, contrary to popular belief, we find no evidence that rising rates or increasing volatility have helped active funds’ performance.”

We can’t help but note that the source of this data (BofAML) is one of the world’s largest providers of active management through its brokerage operations offered to both individual and institutional investors such as company retirement plans. While 65% of U.S. equity assets are still actively managed, the trend towards passive/indexing continues unabated. Specifically, according to Morningstar, investors pulled out $257.5 billion from actively managed U.S. equity funds and added $217.2 billion to passive funds. At Clarity, we would love to see this trend continue, as investors are better served through higher diversification and lower costs.