Stock pickers are having another dismal year.
Twice a year, Morningstar publishes a report that measures the performance of U.S. active funds against their passive peers in their respective Morningstar categories.Their latest conclusion: Stock pickers are not only not winning, they are losing ground against their passive brethren.
Just 36 percent of active U.S. stock fund managers outperformed their passive peers over the last 12 months through June 2018, according to the report released on Thursday. It wasn’t much better a year ago. Just 43 percent outperformed in 2017.
“Most active managers’ long-term track records leave much to be desired,” Ben Johnson, Morningstar’s director of global ETF research and the author of the report, said. “In general, actively managed funds have failed to survive and beat their benchmarks, especially over longer time horizons.”
It’s not a complete rout. Some non-stock categories fared better. In the intermediate bond category, 70 percent of active managers beat their passive rivals. Active managers loaded up on credit risk as both investment grade and junk bonds have done well.
There are two big reasons active stock managers can’t get any traction.
First, they have cash on the sidelines and the wrong mix of investments. “Active managers tend to have difficulty keeping up with index funds in strong markets, as many will keep cash on hand to make opportunistic investments or meet redemptions,” Johnson said. Underweighting winners is another issue: “If you’re underweight Apple in the last year, for example, you are going to underperform.”
Second, they charge fees. “The highest hurdle active managers face is their own fees —- their compensation,” Johnson said.
Active funds that charged the lowest fees were able to outperform their passive competitors 17.9 percent of the time (still a pretty low beat), but those that charged the highest fees were able to beat their passive competitors only 4.9 percent of the time.
In a sign investors are clearly paying attention to fees, Johnson noted that the above-average success of the lower-cost funds was partly explained by higher survivorship rates. The cheaper funds are more likely to survive for a simple reason. “Most of the money has been going to the cheapest funds,” he told me.
Johnson noted that picking the highest quality, cheapest competitor was important for both active and passive funds. “You have better odds if you pick cheap passive funds, and you have better odds if you pick cheap actively managed funds.”
Johnson’s conclusion: “Investors would greatly improve their odds of success by favoring low-cost funds, which succeeded far more often than high-cost funds over the long term.”