In the Media | The Wall Street Journal

Bearish positioning, less exposure to big tech stocks hurt active fund managers

By Vicky Ge Huang

April 10, 2023 5:30 am ET

Stock pickers missed out on the first-quarter rally, failing to extend their recent winning streak.

Only one in three actively managed large-cap mutual funds beat their benchmarks in the first three months of the year, the worst performance since the three-month period ended December 2020, according to data from Bank of America Global Research.
That marked a shift from last year when 57% of large-cap mutual funds raced ahead of their benchmarks in a market rocked by red-hot inflation, rising interest rates and worries over a potential recession. More funds beat their benchmarks in 2022 than in other any year since 2007, when 71% of them did so, according to data compiled by Goldman Sachs Group Inc.

Heading into this year, active fund managers were largely positioned for more of the same—a bear market with a tilt toward value over growth stocks, investors and analysts say. Then
Apple is one of three companies that helped drive the S&P 500’s returns in the first quarter. Then stocks rallied to kick off the year, led by shares of fast-growing companies. In March, troubles in the banking industry rattled financial markets and sparked contagion fears.
Yet markets proved to be more resilient than many investors thought possible. The S&P 500 rose 7% in the first quarter, while the tech-heavy Nasdaq Composite Index climbed 17%, outperforming the Dow Jones Industrial Average—which is largely populated by old-economy stocks—by the widest margin since 2001. Against that backdrop, passive strategies fared better.

For many active investors, trimming their positions in big tech stocks in favor of financial and energy stocks backfired. Bank stocks were clobbered after the abrupt collapses of Silicon Valley Bank and Signature Bank, while energy stocks, which soared in 2022, fell in the first quarter along with crude-oil prices.

A top-heavy stock market further exacerbated active managers’ woes.

Just three stocks—AppleInc., AAPL-2.45% MicrosoftCorp. MSFT-1.86% and NvidiaCorp. —drove NVDA 1.01% half of the S&P 500’s returns in the first quarter, said Savita Subramanian, Bank of America’s head of U.S. equity and quantitative strategy, in a research note. Tech stalwart Apple, which active funds were on average 40% underweight, accounted for more than 20% of the benchmark’s return during this period, she said.

The dynamic is reminiscent of what happened in the decade after the 2008 financial crisis when active managers missed out on gains because of a broad underweighting in big tech.

Stock pickers struggled to beat their benchmarks in the decade following the crisis. Ultralow interest rates, easy monetary policies and a strong U.S. economy fueled a bull run that drove major indexes to record highs. Optimistic investors bid up shares of megacap tech stocks so much so that they grew to represent the majority of the S&P 500. “I’m skeptical that we’re going to continue to see this narrow leadership,” said Garrett Aird, vice president of investment management and research at Northwestern Mutual Wealth Management Co. “I don’t necessarily think it’s healthy when a handful of stocks are driving all of the returns for an index.”

Mr. Aird said his firm uses a mix of active and passive funds in client portfolios depending on asset classes. For large-cap growth funds, they tend to get exposure through index-tracking exchange-traded funds, while favoring active over passive in less-efficient areas of the market such as small-cap stocks.

Indeed, despite small-cap stocks trailing their large-cap peers by the widest margin since March 2020, 52% of small-cap fund managers outperformed their Russell 2000 benchmarks in the first quarter, according to Bank of America data.

Some investors say they believe active managers who fell behind in the first quarter will have another chance to catch up as greater volatility is likely to creep back up into the market in the second quarter, creating more opportunities for stock pickers.

James Demmert, chief investment officer at Main Street Research, which manages about $2 billion in client assets, said elevated interest rates are here to stay for the next several months.

Friday’s jobs report showed that U.S. hiring cooled in March as employers added 236,000 workers, and the unemployment rate slipped to 3.5%. Meanwhile, earnings expectations have contracted sharply ahead of the kickoff of first-quarter earnings season.

“You’ve got a collision course of the Fed saying we’re going to keep tightening, the economy weakening and earnings crumbling; that usually is a good recipe for a bear market rally to give up and go through another decline,” Mr. Demmert said. “And that will give all those active managers one more chance to get in there and get their hands dirty with the Nvidias and the Apples of the world.”

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