You might think that professional money managers are highly skilled at picking stocks that outperform, but that doesn’t seem to be the case.
A new analysis from researcher Morningstar found that 90% of mutual fund managers over a recent 10-year stretch picked more losing stocks than winners, with success determined by whether the stocks beat or lagged an appropriate market index — not whether they generated an actual gain or loss. In other words, a manager could fill a portfolio with a bunch of laggards yet still generate a positive overall return, especially in a fast-rising market. In fact, that scenario seems to be common.
The study looked at stock-picking success or “hit rates” across several fund categories and found that higher rates helped but didn’t guarantee superior performance. Even when managers have a hot hand initially, they usually struggle to keep up that momentum.
“Picking winning stocks is easier said than done,” wrote Jack Shannon, a Morningstar senior equities analyst who conducted the study.
What does boost returns is finding and hanging on to a relatively few big winners, Shannon determined. That is, making large, high-conviction bets on eventual outperformers is the way to go, assuming those decisions bear fruit.
One conclusion from this study is that you should be skeptical any time a professional, or just a friend, brags about his or her stock-picking prowess. Another is that many managers show hot hands from time to time, yet this momentum tends to fizzle.
A third is that index funds, which own a fairly stable assortment of stocks without trying to pick outperformers among them, can represent more predictable alternatives. That is especially true since index funds, which try to replicate the performance of market indicators like the Standard & Poor’s 500, also typically charge lower shareholder-borne expenses than actively managed rivals. Lower costs magnify that edge.
The indexing benefits are nothing new, though the Morningstar study provides new insights. For example, indexing giant Vanguard reported that 82% of its nearly 220 bond and stock index funds beat their actively managed peers over the 10 years ending June 30, 2023. Actively managed funds are those in which a manager is trying to select stocks, or bonds, that outperform the market.
In short, identifying stocks likely to outperform isn’t easy, even for professionals. “Individual investors should remember that if well-resourced professional money managers struggle to get half their picks right, the odds for amateurs are long, too,” Shannon wrote.
Some indicators point to further stock market gains
Despite the sharp stumble on Feb. 13 over lingering inflation worries, the stock market has been performing well of late, and that might bode well for the rest of the year.
One favorable sign was the Standard & Poor’s 500 index closing above 5,000 for the first time on Feb. 9. When major round-number milestones like this are breached, investors tend to climb on board, contends Adam Turnquist, an investment strategist for LPL Financial.
He looked at nine prior milestone breakthroughs for the S&P 500 spanning several decades and concluded that stocks tend to continue rising. Of the last nine that he examined (when the S&P 500 broke through 100 through 500, then 1,000 through 4,000), the index usually kept going, posting an average return of 10.4% over the subsequent 12 months. Investors seem to get excited by the publicity, with many becoming fearful of missing out on the rally, Turnquist said.
The stock market registered a modest gain this past January, and that too could point to 2024 finishing on the plus side, said Turnquist and Jeffrey Buchbinder, LPL’s chief equity strategist, in a separate commentary. This is known as the “January barometer,” and it’s a bullish sign.
“Over the course of the year, we expect easing inflation, stable or lower interest rates and an expected ramp-up in earnings to support additional modest gains for stocks,” they added.
Even the presidential election cycle might give a further boost to keep the market moving higher. This is the tendency of stocks to rally during presidential-election years and years like 2023 that precede them.
Mutual funds mark key anniversary
The mutual fund industry is celebrating the centennial of the first such portfolio in the U.S., when Massachusetts Investors Trust first opened its doors in 1924. Few financial innovations have had more of an impact since then, especially for middle-class investors.
More than 116 million Americans rely on funds to pursue their financial goals, whether saving for education, homeownership, retirement or something else, noted the Investment Company Institute, the fund-industry trade organization. “Funds are the original and greatest democratizing force in global financial markets,” the group said.
Mutual funds and their close cousins, such as exchange-traded funds, provide accessibility and flexibility to enter the stock or bond markets. They can help investors gain stakes in other areas, including money-market products, real estate, precious metals or foreign assets.
They are diversified, professionally managed, inclusive and affordable to people with even a few thousand dollars to invest, or less.
Funds also have become more efficient over time, sharing greater cost savings and economies of scale with their investors. They have become mainstays in workplace 401(k) plans, Individual Retirement Accounts, college-saving 529 programs and more. Collectively, funds counted $25.5 trillion in assets at the end of 2023.
Reach the writer at russ.wiles@arizonarepublic.com.
This article originally appeared on Arizona Republic: 2024 stock market outlook encouraging, but even pros get it wrong
