They have faced the stiffest possible headwinds.
Absolutely Fine, Relatively Miserable
Last month, Bloomberg's Matt Levine wrote, "The basic process of value investing is that you go look for stocks that are underpriced relative to their fundamentals, and you buy them, and you wait for everybody else to notice how underpriced they are, and you get tired of waiting, and you go to complain to the press about how undervalued your stocks are."
Indeed. However, Levine's lesson should be generalized. The basic process of active investing is to buy stocks the rest of the world doesn't understand, await other investors' enlightenment, become frustrated with their stupidity, and then complain about how index funds have ruined the market.
My sympathies are … slight. However, in some fairness to U.S. stock-fund managers' cause, they have struggled against every conceivable headwind. Not, of course, in terms of their funds' absolute performances, which have been terrific, but in terms of their relative showings, which have them in aggregate stumbling behind their benchmarks, year after year.
Aside from simply selecting better securities while keeping their risk profiles similar to those of the indexes against which they are measured, domestic-stock fund managers have three ways to win: 1) diversifying into different asset classes; 2) betting heavily on a few industries; and 3) spreading among several investment styles. Unfortunately, all three tactics are failing.
There's No Place Like Home
Forget about the first strategy, that of owning other assets. Nothing has been able to keep pace with U.S. stocks, which have appreciated with barely a hitch since their 2009 bottom, providing nothing but misery for those who have bet against that asset class. Fixed-income securities and almost all foreign stock markets have flourish during that time period, yes, but their gains pale in comparison to what U.S. stocks have accomplished.
Consider the lowest five-year returns among the diversified U.S. equity fund Morningstar Categories, large-value funds, against several possible alternatives: developed-markets stocks; emerging-markets stocks; intermediate-term bond funds; and cash (represented here by short U.S. government funds). None of the challengers came close. Virtually without exception, any U.S. stock fund that deviated from holding only domestic equities during the past five years regretted that decision.
On the bright side for active managers, industry performance has been much more varied. The top sectors (technology and healthcare) have gained more than 17% per year during the trailing five years, two areas (energy and precious metals) are down for the period, and several others have muddled along with only modest gains. Any fund manager who weighted technology or healthcare stocks significantly more than did the stock-market indexes stood a good chance of beating the benchmarks.