Active managers are on a winning streak. That won’t last

Representative Image

Stock pickers are beating the market in unusually large numbers this year, raising the age-old question about whether their success can be attributed more to luck or skill.

Nearly 70 percent of the roughly 2,850 actively-managed US stock mutual funds with the stated goal of beating the S&P 500 Index have done so this year through last week. That’s a vast improvement from last year, when just 15 percent of US large-cap stock pickers beat the market, according to S&P’s latest SPIVA report tracking the performance of active managers. It’s also much higher than normal. On average, roughly 35 percent of managers have outpaced the S&P 500 in any calendar year, based on annual results back to 2007.

Graph1

Even so, the results this year aren’t entirely surprising. Most stock pickers invest in a broad cross section of the market, from fast-growing technology companies to boring banks and manufacturers. Until recently, tech stocks were the best performers for many years, which ballooned their market value relative to other stocks, and gave them an ever-larger slice of indexes like the S&P 500 that weight stocks by size. While tech was hot, it was impossible for a broadly diversified portfolio to keep up. Now it’s just the opposite — with tech stocks leading the declines, well-rounded portfolios have the edge.

It’s a mistake, however, to assume that active managers’ recent success will persist. The evidence is overwhelming that the longer they play the game, the more likely they are to lose. The latest SPIVA report is typical: Just 17 percent of US large-cap stock pickers beat the S&P 500 over the past 10 years through 2021, and that number drops to 6 percent over 20 years.

Time makes a fool of most stock pickers. Institutional investors once called hedge fund manager Gabe Plotkin a “wunderkind” after he racked up gains of 30 percent a year over a half-decade. Billionaire Ken Griffin, who backed Plotkin’s fund, called him “an iconic investor” who “did an incredible job for his investors” in a recent interview with Bloomberg Intelligence.

Now Plotkin is closing his fund after declines of 39 percent last year, and 23 percent this year through April. Griffin’s reaction: “The average hedge fund lives for about three years. So several hundred shut down a year and the world goes on.” So much for skill.

Even more revered is Chase Coleman, founder of hedge fund Tiger Global Management. His two-decade-old fund reportedly generated returns of more than 20 percent a year through 2020, aided by big bets on technology. Now those bets are souring. After a down year in 2021, Coleman’s main hedge fund is down 44 percent this year through April, and his long-only fund has tumbled 52 percent. What happened? “Markets have not been cooperative,” Tiger Global wrote to investors. They rarely are to stock pickers.

Not even the most admired track records are necessarily a show of skill. Perhaps the most revered belongs to Peter Lynch, who racked up a return of 29 percent a year at the helm of Fidelity’s Magellan Fund from 1977 to 1990, including dividends. He outpaced the S&P 500, the fund’s benchmark, by more than 13 percent a year during that time.

Graph

That may seem like stock-picking mastery, but not so fast. For one, Lynch didn’t invest in the S&P 500. He bought high-quality companies that traded at a reasonable price, a blend of two strategies — quality and value — that are well known to have outpaced the market historically.

As it happened, the combination of the two strategies beat the market by a huge margin while Lynch led Magellan. A blend of the most profitable and cheapest 20 percent of US stocks, weighted equally, returned 28 percent a year during that time, according to numbers compiled by Dartmouth Professor Ken French, nearly matching Lynch’s performance. Both Magellan and the profitability/value blend are also comparably volatile, and about a third more volatile than the S&P 500, another indication that the profitability/value blend more closely captures Lynch’s investing style than the S&P 500.

Graph3

So there doesn’t appear to be any magic in Lynch’s stock picking. He was merely fortunate that his investing style was in favour during his 13 years at Magellan. That’s not always the case. If he had plied his style during the preceding 13 years, he would have likely generated a return closer to 6 percent a year, or 1 percentage point better than the S&P 500. In fact, back to 1963, there is no other period outside of the late 1970s and 1980s in which Lynch would have done nearly as well. If his record fades under scrutiny, imagine how dull other managers look.

Keep all that in mind when you hear about stock pickers beating the market this year. There may be a handful of them with long, successful track records that can’t be fully explained by their investing style. Warren Buffett, David Tepper, and Chris Hohn come to mind. But they are vast exceptions. Everyone else probably got lucky.

Nir Kaissar is a Bloomberg Opinion columnist covering markets. He is the founder of Unison Advisors, an asset management firm. Views are personal, and do not represent the stand of this publication.