Mutual fund trends: Give stock pickers a chance?

By Stan Choe
AP Business Writer

NEW YORK (AP) - Bad news keeps piling up for stock pickers, but not everyone is giving up on them.

The majority of actively managed mutual funds continue to fall short of index funds, and investors are voting with their feet, pulling out billions of dollars from those funds every month in search of cheaper and better options. Defenders of portfolio managers say the moment may be nearing when they prove their worth: when markets get shaky.

This week, we take a look at actively managed funds, strategies for stabilizing a portfolio in rocky times and other trends from around the fund industry.

- Give stock pickers a chance?

Trying to beat the market has long been a losing proposition.

Over the last decade, investors would have been better off with an index fund that tracks the Standard & Poor's 500 than the vast majority of large-cap mutual funds run by stock pickers. Only 20 percent of actively managed large-cap funds managed to beat the index over the 10 years through June, according to S&P Dow Jones Indices. The numbers are similar for funds focusing on mid-cap stocks, small-cap stocks and other areas of the market.

By keeping expenses low, index funds have a built-in advantage over many other funds, and investors have noticed. They've pulled more than $150 billion from actively managed U.S. stock funds over the last year, according to Morningstar. Much of that has gone into index funds.

Yet it's often just when everyone has become sick of something when things can turn around, proponents say. The last few years have been tough for stock pickers because big stimulus efforts from the Federal Reserve have lifted all stocks, says Lisa Shalett, head of investment and portfolio strategies for Morgan Stanley Wealth Management.

With the Fed's bond-buying program over and the first increase in interest rates in nearly a decade approaching, Shalett says stock pickers may be able to differentiate themselves.

Capital Group, whose American Funds is the third-largest fund family, points to how some active managers have a better history of minimizing losses during down markets. Not only does that help support the funds' long-term returns, it may also help keep skittish investors from jumping out and selling low, only to miss a subsequent rebound.

"If you can moderate that swoon, if you can make it a little less painful, you increase the chance that people stay invested," says Rob Lovelace, senior member of Capital Group's management committee.

That's why he suggests investors look not only at expenses when choosing a mutual fund, but also how it performs during down markets and whether its managers invest in the fund themselves.

- Is a fund manager from an Ivy League school better?

Mutual fund managers who went to Harvard and other elite universities tend to make more money for their investors, but it may have nothing to do with smarts.

Instead, it's likely about connections, say researchers from Nanyang Technological University in Singapore and the University of Texas at Austin. They looked at why managers from top schools tend to have slightly higher returns, about 0.6 percentage points per year. They traced much of it to relationships the managers have with investment bank executives, many of whom went to those same top schools.

Those relationships mean fund managers from elite schools get more access to hot initial public offerings of stock, ones that often result in a jump of 10 percent or more on the first day of trading. The researchers looked at 1,420 fund managers and spanned two decades of data, from 1992 to 2012. They found that it's during these months when IPOs are allocated where managers from top schools really separate themselves from other managers. Otherwise, the performance wasn't that much better.

As in other things, it may not be what you know, but who you know.

- Investors are looking beyond stocks and bonds for stability.

When stocks tumbled in August, the usual landing spot for those seeking safety, the bond market, was flashing warning signs of its own. The worry was that the Federal Reserve was about to raise interest rates, and higher rates can cause bond prices to fall.

Those fears led investors to pull more than $20 billion out of bond mutual funds and exchange-traded funds last month. Another $6 billion left stock funds as the S&P 500 had its first correction since 2011.

Some of that money went into mutual funds that the industry is pitching as a steadier alternative to stocks. They go by many names, but many essentially offer strategies that are similar to hedge funds. These "alternative" funds can make money when stocks fall by selling them short, for example. The industry says their wider assortment of tools allows these funds to offer a smoother ride without the interest-rate worries that bedevil bond funds.

Alternative funds drew in $3.2 billion in net investment last month, one of the few categories to attract money. To be sure, many alternative funds also had losses during August, but the drops were generally milder than for stock funds.

The question for investors is whether these alternative strategies are worth the higher expenses that these funds tend to carry.

Published: Fri, Oct 02, 2015