Stock pickers off to good start in ’17

January aside, track record shows large-cap managers have trouble beating Wall Street

A Wall Street-style revenge of the nerds could be underway in the investing world.

Beleaguered stock pickers that run funds that invest in big U.S. stocks are flashing signs of a comeback in their well-publicized battle with “passive” funds, such as index funds and exchange-traded funds that track and mimic the performance of benchmarks such as the Standard & Poor’s 500 and Russell 1000 stock indexes.

In January, 52.4% of active large-cap fund managers — brainy, spreadsheet-toting financial folks that pick stocks with the intent of beating the market — posted returns that topped the benchmark large-company Russell 1000, data from Bank of America Merrill Lynch show. That’s up from just 26% of managers beating the benchmark in December and just 19% who outgained

the in- dex, which consists of the 1,000 biggest U.S. companies, last year.

Says Ben Johnson, director of global ETF research at fund research firm Morningstar: “Active management is not dead.”

Still, fund managers in the mold of one-time market-beating legends, such as retired Fidelity Magellan manager Peter Lynch and ex-Legg Mason Value Trust manager Bill Miller, are a vanishing breed. Indeed, funds run by managers that do voluminous stock research in hopes of separating winners from losers have been falling short in the performance derby vs. the benchmarks they’re paid to beat.

U.S. stock funds run by stock pickers have posted smaller returns than passive funds for three consecutive years and have fallen short six of the past nine years going back to 2008, according to Morningstar. In 2016, passively

managed domestic stock funds returned an average 14.6%, more than 3 percentage points better than actively managed funds.

The performance shortfall can be attributed to persistent headwinds. For example, funds run by stock pickers, unlike index funds, typically don’t have 100% of their assets invested in stocks. Cash is a drag in up markets, making it harder to maximize returns in prolonged bull markets.

Actively managed funds also suffer a performance drag from their higher fee structure. U.S. stock funds run by stock pickers carry an average expense ratio of 1.27%, vs. just 0.53% for passively managed funds, according to Morningstar. Active funds have also been hindered by a mass exodus of cash, with more net money flowing out than in for 11 consecutive years. In 2016, investors yanked $264.2 billion out of U.S. stock funds run by portfolio managers, Morningstar data show. In contrast, passive ETFs and index funds enjoyed net inflows of $236.7 billion last year.

So what factors helped funds run by stock pickers do slightly better than passively run funds?

In high-correlation market environments pretty much everything moves up and down together, which makes it tough for stock pickers to stand out. But lately stocks have been moving less and less in tandem, giving stock pickers more of an edge, says Dan Suzuki, equity and quant strategist at BofA Merrill Lynch.

There is a wider range in returns from stock to stock and sector to sector, which favors stock pickers that correctly identify the winners.

Fund managers parked their money in the right corners of the market in January.