To say that 2011 has severely tested the world’s most high profile of investors is no exaggeration. The likes of Fidelity’s Anthony Bolton, Pimco’s Bill Gross and hedge fund manager John Paulson have all delivered below par performances this year.
But it has been a truly horrible year for more traditional investors who delve into the details of company balance sheets and try to buy stocks that offer compelling value.
Last week, for example, Bill Miller of Legg Mason, one of the leading fund managers of his generation, called time on his management of the flagship Capital Management Value Trust after a dismal performance in recent years.
While Mr Miller was a stockpicking star for 15 years, he has struggled since 2006 as movements in shares prices have become increasingly correlated with one another, a trend that has been dubbed “risk on, risk off” since the financial crisis.
“It’s just a much more difficult period, I’m assuming, for all active managers,” he says. “Growth has done better than value, but risk on, risk off has been the name of the game for the last two years”.
Another well known “value” investor, Bruce Berkowitz, has seen his Fairholme Fund suffer a drop of 32 per cent so far this year. Tilson Focus, the mutual fund run by hedge fund manager Whitney Tilson, is down 23 per cent so far this year, a performance that still puts it in the top quartile for its category, according to Morningstar.
For US equity investors, it is clear that the underlying investment environment has changed. While many stocks look cheap on various valuation models, these bargains have loitered like unsold toys on shop shelves after Christmas. Notable examples include Microsoft, PepsiCo and Procter & Gamble.
This is reflected in the performance of the S&P value index, which has dropped 9.5 per cent since the start of January. By contrast, the S&P growth index has fallen 1.8 per cent.
Janet Brown, president of DAL, an investment company, argues that individual stockpicking ability is less important than investment fashion. “Fund performance tends to be down to whether the strategy is in sync with the market environment, rather than the brilliance of the manager,” she says.
Indeed, for much of this year, stocks have generally moved together, with investors either buying or selling the asset class. These tidal movements have frustrated ardent stock pickers.
“When stocks are moving in lock step, investors might as well put their money in an S&P500 tracker and cash out when they think the market is going to turn,” says Oliver Pursche, a stockpicking fund manager at Gary Goldberg Financial Services.
In such an environment, however, some stocks have outperformed. “Stock picking is not dead, it’s just become a lot more difficult,” says Nicholas Colas, director of research at Convergex.
The 25 best-performing stocks in the S&P 500, excluding four companies that have been bought out in mergers and acquisitions, are up an average 36.2 per cent this year, according to data from Convergex. The list includes Lorillard, the cigarette manufacturer, a high dividend paying stock that has climbed 32 per cent this year.
Channing Smith, a mutual fund manager at Capital Advisors, still uses the old-fashioned stockpickers’ tools to select companies, looking for rising operating margins and revenues and signs that the company is gaining market share. But the macroeconomic environment has complicated that analysis.
“If it wasn’t for the situation in Europe we’d be very happy investing in US equities, but the potential for the eurozone’s problems to morph into a credit crisis holds us back,” he says.
Stockpickers also face a challenge in retaining the faith of investors in their funds. A Standard & Poor’s study in August found that two-thirds of actively managed large-cap equity funds have underperformed the S&P 500 over the past three years. Many equity investors have instead embraced exchange traded funds, which offer immediate exposure to an index or basket of equities at low cost.
Fund managers’ greatest fear is a rerun of the 1930s and 1940s. Stock picking only returned at the end of that period, when investors had stopped paying attention to equities altogether. That point has not arrived yet, but it may be looming. While company specifics accounted for 50 per cent of performance in the median S&P 500 stock over the past 20 years, that figure dropped to a low of 30 per cent this summer, says Adam Parker, chief US equity strategist at Morgan Stanley.
“Macro factors will matter just as much for stock prices in the next six months as they have in the last few,” he says. Active fund managers are likely to remain on guard, lest their stockpicking efforts are blindsided by macro-driven markets.
“It’s a nice cafeteria you have out there in the market,” says Mr Miller, who insists “there is no dearth of cheap stocks.” The moment when that value will be recognised is far harder to identify.
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