"February Should Have Been A Better Month" - Only 35% Of Managers Beat Their Benchmark

With pairwise correlation between stocks plunging since the Trump victory, leading to a jump in stock return dispersion, conventional wisdom quickly agreed that this would be the ideal environment for "stock pickers" and especially downtrodden hedge funds, the majority of which have underperformed both their benchmark and the S&P 500 ever since the SAC and Galleon insider trading scandals blocked the use of "expert networks."  Alas it was not meant to be.

According to the latest monthly mutual fund performance update from Bank of America, while stocks continued to set record highs, resulting in another solid month for US equities, it was another month to forget for active managers. The bank found that managers across size segments and styles (with the exception of mid cap Growth) underperformed their benchmarks in February.

Large cap funds lagged the most, with only 35% of the managers beating the benchmark, down from 52% the prior month. This was largely due to the underperformance of Growth managers, despite having the best absolute returns (+3.7%) across all size and style segments in February. Large cap Growth funds struggled to keep pace with the outperforming benchmark (+4.2%), with just 21% outperforming, down from 73% in January. Value and Core managers fared better, but only 45% and 40% outperformed their benchmarks in the month, respectively.

Indeed, February should have been a better month for stock-picking, with pair-wise stock correlations continuing to fall to their lowest levels since 2000.

Alas, it wasn't, and as Savita Subramanian's team writes, "better backdrop for stock-picking does not necessarily equate to fund managers making the right picks." The reason: active managers’ consistent bias towards low quality and high beta was likely a drag on  performance, as both of these factors had poor performance in February.

Sector positioning was also likely a headwind to performance despite two out of their three overweighted sectors (Health Care and Tech) outperforming in February. Fund managers’ biggest overweight (Consumer Discretionary) underperformed by 2ppt while their two biggest underweights (Real Estate and Utilities) outperformed for the month.

And so another month of underperformance for the active community, which will lead to even more outflows and, correspondingly, more inflows into ETFs. Will 2017 end up as bad as 2016? It is hard to say: last year only 19% of active funds was able to outpace major indexes, resulting in a near record outflow from the actively managed community, as some $396 billion was redeemed and then reallocated into index funds and ETFs. As Bloomberg notes "the pressure to justify higher fees is hammering all corners of the mutual fund industry -- even benchmark-beating funds couldn’t escape an onslaught of outflows. For managers, this year’s more favorable market environment looked like the path toward redemption."

A few more more months like February and what is rapidly becoming a 1 and 10 model may soon become 0.5 and 5.

There is still some hope though: as BofA adds, "dispersion in returns decreased in February, although the overall trend is till increasing and giving way to more opportunities to generate alpha." Now if only the active management community still remembered how to do that...