According to BofA's Savita Subramanian, just 19% of funds outperformed the S&P 500 in the 1Q. According to the bank, this was the the lowest quarterly hit rate in our data history spanning 1998 to today. The average fund lagged by 1.9ppt, marking a record spread of underperformance.
Even worse, growth funds saw only a 6% hit rate, the worst since at least 1991. According to BofA, "the average fund lagged by the widest margin we have recorded in our quarterly data: - 3.5ppt."
It wasn't quite as bad for value managers who had a better hit rate (19.6%), and Core funds saw the highest quarterly hit rate of 29%.
But March results were the worst in a string of months, with hit rates dropping from to January’s 34% to February’s 27% to March’s 21%.
What caused this dramatic (and latest) underperformance by the large-cap mutual fund community who are after all paid to outperform the market? Here is BofA's explanation why it has become so difficult to outperform the market.
Correlations, dispersion, reversals, positioning…
The recipe for distress may boil down to a few factors. Heightened correlations (Chart 1) and low alpha opportunity (Chart 2) continued to hurt, as stock selection thrives when intra-stock correlations are low and alpha is abundant.
But these contributors to underperformance have been in place for a while - the lit match taken to active returns last quarter was likely the massive reversal – by the market, by sectors, by styles and by stocks - occurring within the quarter. Momentum investors were stymied by the fact almost nothing worked during both halves of the quarter except valuation, a now out of vogue attribute after several years of underperforming. And crowded positions proved particularly damning in the 1Q, with the 10 most crowded stocks underperforming the 10 most neglected stocks by almost 7ppt, an atypically high spread.
With activist central banks having made a mockery of fundamental investing and intervening daily in capital markets either directly or verbally, we don't expect this trend of dramatic active management underperformance to change in the coming months. Which means more active managers angry at passive indexers, which means more "robo advisors", etc.