The renewed selloff in equities is offering bears a moment of vindication. But for professional stock pickers, the past month brought a reminder that being too defensive can be costly. 

The two-month stock rout at the start of the year sent actively managed funds pouring into cash and loading up on bearish wagers. The moves turned sour during the frenetic rally in the second half of March. As a result, long-only mutual funds trailed their benchmarks on average by a full percentage point last month -- the worst performance since 2002, data compiled by Bank of America Corp. show.

Meanwhile, hedge funds that make both bullish and bearish equity bets also found themselves wrong-footed after slashing stock exposure to fresh lows. Forced to cover short positions as the market bounced back and then not adding longs, the group saw flat returns in the month through March 29, according to data compiled Goldman Sachs Group Inc.’s prime broker. That trailed the S&P 500’s 5.9% gain over the same period.

While all the defensiveness can be framed as a bullish sign for the market, the epic underperformance illustrates the challenges of navigating high volatility. Even if the rally was a bear market trap, as strategists from Morgan Stanley to BofA warned, it still brought pain for pros watching their returns languish.

“The magnitude of the rally in March was certainly beyond almost all expectations,” said Mark Freeman, chief investment officer at Socorro Asset Management LP. “Sentiment was very negative going in, especially with the first Fed rate hike on the horizon, which was reflected in the cash and low overall exposure.”

Missing the mark was widespread: only 19% of long-only funds tracked by BofA beat their benchmarks in March. That’s down from 45% in the first two months and the worst reading since 2010.

While many factors may have contributed to the subpar performance, BofA strategists including Savita Subramanian and Ohsung Kwon pointed to two main culprits: elevated cash holdings and a reluctance to embrace energy stocks.

In BofA’s March survey of money managers, cash holdings rose to the highest level since April 2020. While such hoarding helps limit losses during a market retrenchment, it also caps the upside with cash yielding next to nothing.

A persistent aversion to energy producers also hurt performance, as the industry has crushed the market every month this year. During the first quarter, active funds were 27% underweight energy, a stance that BofA estimates shaved 33 basis points off of returns.

The “March bounce left active behind,” Subramanian and Kwon wrote in a note. “All size and style segments lagged.”

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