The last 20 years have been rough for stock pickers. Public assets have been under fire from peers, Indexed ETFs, Quants and Private Assets. It has been very difficult for stock pickers to do the job they learned to do because as the availability of data has increased, so has the scrutiny on these investors. Furthermore, in a free money environment, intrinsic value is nearly impossible to calculate, and this should be what fundamental analysts rely on. What makes this all the more frustrating is that while stocks seem to go up, the stocks that are mispriced on the low side of intrinsic value never seem to go up, while those that are overpriced seem to march interminably higher. That was until the Federal Reserve started raising rates in 2021. For a year and a half, it felt like stock pickers got the break that they needed. Value outperformed growth. Stocks stopped going up in unison, this should be the time to prove their worth and differentiate themselves with stock picking magic.
Unfortunately, for the once mighty equity portfolio manager, a stock picker’s market sometimes only lasts until the next quarter. As we mentioned last week, the stock market was up materially in Q1, but very few stocks and even fewer equity managers were participants. As pointed out by the Wall Street Journal, 3 stocks accounted for half of the Q1 returns in the S&P 500. In fact, Apple, a company that is underweighted by an average of 40% by equity managers accounted for more than 20% of the index return by itself.
Part of this dynamic is structural. Equity strategies often have guidelines that are meant to prevent excess risk, but these guidelines often cause wide swings in performance relative to the benchmark. Part of this is about the drivers of stock performance having changed over the years as market share has shifted from fundamental strategy to that of an indexed strategy. Why? Because many indexed ETFs use a sampling approach to replicate an index. Furthermore, there is a self-fulfilling prophecy as these ETFs take share, when a stock goes up, it becomes a bigger part of the index and it must be bought in higher percentage by the incremental investor than it was by the previous investor. It’s tough to see this as healthy, because it does not rely on price discovery, but this is the stock market as it exists today. No wonder other asset classes keep gaining share.
Sources: Wall Street Journal, Wall Street Journal