What's behind lacklustre performance of active fund managers this year?

Cash emerges as popular hedging tool for Wall Street

What's behind lacklustre performance of active fund managers this year?

Last year’s volatility was lucrative for expert stock pickers but now their returns are lagging. The first quarter had the poorest performance since the year 2020, with only one in three actively managed mutual funds outperforming equities benchmarks. In comparison, 2022 had the highest hit rate in the previous five years at 47%.

The pool of winning companies shrank as a result of a more top-heavy market, and most active funds lost because their bias towards banks backfired. In addition, a conservative strategy that turned out to be inappropriate for an unexpected equities rally aggravated the already unfortunate situation.

“Sentiment was bearish heading into the year, leaving active funds potentially caught off guard by the market rally,” BofA strategists, including Savita Subramanian, wrote in a note.

Following the bear market of 2022, cash has emerged as one of Wall Street's most popular hedging tools. Cash levels remained over 5% for 15 straight months, the greatest stretch since 2002, according to the most recent Bank of America Corp. poll.

Though not insignificant, cash's 5% annual yield was behind the benchmark S&P 500's 7% first-quarter return. Even experienced stock pickers occasionally lag behind the market, and given the threatening environment facing volatile assets, prudence may prove to be wise.

While active management has had a bumpy start to this year, industry bets were also miscalculated, with large-cap core funds favouring financial shares more than any other major groupings aside from industrials, while technology received the least attention.

Bank failures generated a 6% decline in financial shares, but a 21% jump in IT shares. During the first quarter, the most preferred equities in a Goldman basket of mutual funds lagged their least favoured by 7.5 percentage points.

“Mutual funds materially underperformed recently due to their overweight in financials and underweight allocation to mega-cap tech,” David Kostin and several Goldman analysts wrote late in March.

Only 33% of the Russell 3000's constituents outperformed the market in 2018, down from 47% in 2022, further reducing the number of market-beating equities. The tech industry is home to many of the biggest winners. The Nasdaq 100 increased 20% in the first quarter, the largest gap in favour of the latter since 2001.

“Narrow breadth was a headwind for active funds,” said BofA’s Subramanian.