It’s not owning enough of the big winners that has proved to be a larger problem for money managers. Last year, only 38% of large-cap funds beat their benchmark as an aversion to tech megacaps dragged down performance, according to an analysis by BofA.
“Not holding stocks that are big return contributors to the benchmark carries tremendous underperformance risk when these stocks have positive momentum,” said Savita Subramanian, BofA’s head of US equity and quantitative strategy. “As filings are posted at the end of each period, funds may feel some pressure to show that they held the best companies over that period – particularly if the alpha from top stocks and the index is quite wide, as it was last year.”
Going by her team’s data, active funds have been gravitating toward their benchmark since 2017, a period coinciding with tech’s largely unstoppable ascent. Over the stretch, their active share ratio slipped to 65%, down from a peak of almost 70%. The ratio always falls between 0% and 100%, with zero indicating a pure passive strategy while a higher reading suggests more active management.
The active share ratio did perk up over a stretch when tech’s supremacy was briefly interrupted from late-2021 onwards.
Software and internet shares have extended their leadership in the new year, bolstered by optimism that the Federal Reserve will soon embark on a monetary easing cycle as inflation cools, alleviating valuation pressure on richly valued stocks.
To stand a chance of winning, stock pickers need big tech exposure. Not all of them can get it. Regulations dating back over 80 years set limits on how concentrated a “diversified” mutual fund can be. Under those rules, these funds must cap the number of individual securities that equal more than 5% of their assets, and such stakes can’t add up to more than 25% of their overall portfolios.
“As market cap weighted indicies become more and more concentrated in a handful of names, it creates an inherent conflict for active managers who are not willing or able to have such concentrated positions,” said Freeman at Socorro. “In this environment active managers are just trying to keep up as best they can, which means taking index-like positions to the extent possible.”
This article was provided by Bloomberg News.