Robert D'Alelio has the kind of long-term record every mutual fund manager aspires to, beating 98 per cent of his peers over the past 15 years with the $12.6-billion (U.S.) Neuberger Berman Genesis Fund and crushing his benchmark, the Russell 2000 index.
Mr. D'Alelio's performance over the past five years isn't so enviable. He's fallen behind his yardstick, and he's got lots of company. Stock pickers including Donald Yacktman at the AMG Yacktman Fund and the team of Mason Hawkins and Staley Cates at the Longleaf Partners Fund trailed their barometers in the same period after dominating in the prior decade.
Managers say they haven't changed, the market has. The easy money climate of near-zero interest rates engineered by the Federal Reserve has artificially inflated prices of lower-quality U.S. stocks, they say, punishing those who focus on businesses with the best fundamentals. At the same time, the relentless climb of prices across equity markets has left them with few chances to sniff out bargains or show what they can do in more-volatile times.
"In straight-up markets, you don't need active managers," Mr. D'Alelio said in a telephone interview. "If the next five years are the same, there won't be any active managers left."
Twenty per cent of mutual funds that pick U.S. stocks beat their main benchmarks in 2014, and 21 per cent topped the indexes in the five years ended Dec. 31, according to data from Chicago-based Morningstar Inc. Over 10 and 15 years, the winners rise to 34 per cent and 58 per cent, respectively.
Investors have expressed their displeasure by moving money to low-cost funds that mimic indexes. In 2014, actively run U.S. stock funds suffered $98-billion in redemptions, while index funds took in $167-billion. Passive managers represent 38 per cent of the $8.7-trillion stock fund business, more than twice their share 10 years earlier, Morningstar data show.
The shift may be ill-timed if the herd mentality comes to an end. Lagging behind the market will motivate managers to change their investment process and common sense will prevail as the economic cycle ages and fundamentals are rewarded, Brian Belski, chief investment strategist at BMO Nesbitt Burns, wrote in the firm's 2015 outlook published in December. "From our lens, this means a prolonged period of active investing is upon us, thereby overtaking the macro or index biased ways that have engulfed investing the past 15 years," Mr. Belski wrote.
Stocks have moved in lockstep to an unusual degree since the 2008 financial crisis, a handicap for managers seeking to exploit market inefficiencies.
Monthly dispersion among Standard & Poor's 500 index members, a measure of how far individual stocks are swinging relative to the market, narrowed for a fifth year in 2014 and in August reached the lowest level since 1979, data compiled by JPMorgan Chase & Co. and Bloomberg show.
As stocks started moving more on their own this year, 46 per cent of active managers were beating their benchmarks as of Jan. 31, according to Morningstar.
Regardless of whether the trend is turning, Jeff Tjornehoj, an analyst with Denver-based fund tracker Lipper, doesn't buy the idea that certain types of markets are tougher on stock pickers. "It sounds like a team complaining about the rain when everyone has to play under the same weather," Mr. Tjornehoj said.
Jim Rowley, a senior analyst at Vanguard Group Inc., is also dubious of high stock correlation as an explanation. In each of the past eight years, at least 70 per cent of the stocks in the broad Russell 3000 index either beat or underperformed that benchmark by 10 percentage points or more, according to Mr. Rowley, whose firm is known for championing index funds. "That would suggest there has been ample opportunity to pick winners and losers," he said.
The Yacktman Fund, after beating competitors in the market selloffs of 2002 and 2008, has averaged annual returns of more than 13 per cent in the past 15 calendar years, handily beating the S&P 500. Over the past five years, the fund trails the benchmark. Investors withdrew $1.7-billion in 2014, according to Morningstar estimates.
The current market is reminiscent of the late 1990s, say Mr. Hawkins and Mr. Cates, who have overseen the $7.5-billion Longleaf Partners Fund for more than two decades and still have a top 15-year record.
Then, as now, stocks marched higher "while fundamentals mattered little," the pair told shareholders in a January letter. Once the dot-com bubble burst in 2000, stock pickers eventually regained favour. "At this moment of relative weak performance with active management in disrepute, our optimism about future relative performance is exceptionally high," the two wrote.