Money managers caught off guard as stock market shifts

Only 29% of core mutual funds outperformed their benchmarks in January

Money managers caught off guard as stock market shifts

Stocks bucked all bearish predictions to post a strong rebound in January that increased the S&P 500 by 6%. But money managers who had increased their cash ballast amid the bear market of 2022 may have been caught off guard as their returns were hampered by the defensive strategy.

Only a few weeks after expert stock pickers had enjoyed their best annual performance since 2017, the winds of fortune in the stock market changed, reported Bloomberg.

In the first month of 2023, just 29% of the core mutual funds that Bank of America Corp. was tracking outperformed their targets --- their poorest performance since last July. Three fifths (61%) of these ETFs bested their benchmarks in 2022.

“By mid-December, the ‘1H down, 2H up’ equity call was firmly the consensus, driving us to highlight that the key risk heading into 2023 was that of being underinvested or of being too defensive,” BofA strategists including Savita Subramanian and Ohsung Kwon wrote in a note Thursday. “We now hear the reverse mantra ‘up in 1H, down in 2H,’ but we think clients are not fully positioned as such.”

Professional investors stood helpless as they watched all the patterns from the previous year reverse in the beginning 2023. After underperforming in 2022, cyclical companies are now outperforming defensive shares. Small-cap vs large-cap, as well as growth against value, both saw a similar about-face.

As a result, last year's top-performing funds, such as value and quant funds, started to disappoint. Growth funds, which mostly lagged in 2022, had a good January.

As confidence in the Federal Reserve's capacity to control inflation increased in the new year, stocks edged higher. Dropping bond rates have relieved some of the heat on once-expensive, undervalued equities like software and internet businesses, a sector that received scant support from money managers near the end of last year.

As technology companies recovered in January, core funds that had a growth or value orientation fell. Research from Goldman Sachs Group Inc. from December found that mutual funds were most underweight in technology. The average fund’s holding of the largest technology companies, including Apple, fell by about 5 percentage points compared to their exposure in a benchmark.

The tech-heavy Nasdaq 100 surged 11% in January, while Apple, the largest American company by value, also increased by a comparable amount. This aversion was a drag on fund performance. That's roughly twice as much as the S&P 500's gain throughout that time frame.

Goldman claimed that the industry's favoured equities -- which mostly consisted of the banking and healthcare sectors -- did not perform as expected. The S&P 500 and a basket of these businesses underperformed by more than 1% in January, the worst result in six months.

Some of the best-performing funds have fallen behind owing to the market's turbulence. Since the beginning of January, Jeff Muhlenkamp's Muhlenkamp Fund has lagged the S&P 500 by 5 percentage points. The fund earned a positive return as an outlier during last year's equities crash. The choice to invest around one-third of its funds in cash contributed to the poor results.

Given the limited amount of cheap-looking equities and his belief that this new-year rally is merely another bear-market trap, Muhlenkamp is still hesitant to invest the money. Data gathered by Bloomberg shows the S&P 500 is trading above its 10-year average at 18.5 times earnings.

“To be wrong in the short term isn’t uncommon,” Muhlenkamp said in an interview. “I may not be right every month, but my goal is to be right a little bit longer term than that.”