The Toronto Stock Exchange in Toronto on Nov. 1, 2023. Only one in four Canadian active fund managers focused on U.S. stock picks have outperformed the market.Chris Young/The Canadian Press
Every year, investors are promised a “stock picker’s market” that never seems to materialize.
The investment industry is perpetually claiming that the moment has arrived for active investment strategies to carry the day over low-cost index funds.
This year, the stars seem to have aligned. But still, active fund managers can’t seem to seize the moment.
Technical indicators show that stocks are behaving independently to an unusual degree. While the U.S. stock market as a whole has been consistently on the rise of late, the individual stocks that make up the market are doing their own thing. An index of implied correlation from options exchange Cboe, for example, hit a record low last week.
These are just the kinds of conditions stock pickers hope for. And yet, fewer than one in five actively traded investment funds in the U.S. managed to beat the S&P 500 index in the first half of the year, according to data from research firm Morningstar.
Canadian active fund managers aren’t having a great year either. Only one in four funds focused on U.S. stock picks has outperformed the market.
Canada-focused equity funds, meanwhile, have a slightly better record, with roughly one-third of funds surpassing the S&P/TSX Composite Index year to date.
Still, that’s hardly a banner year for stock picking.
“Active managers sell the dream of outperformance. They don’t actually outperform,” said Terence Shaunessy, a portfolio manager at Forstrong Global Asset Management in Calgary.
This is true over virtually any time frame. Widen the lens out to a decade – a long-enough stretch for any stock picker to prove their mettle – and the results are similar.
Morningstar figures show that only 21 per cent of funds actively investing in Canadian stocks posted a higher annual return than the Canadian benchmark index over the past 10 years.
There are two big reasons why this number is so low.
The first is fees. The average equity mutual fund charging a management expense ratio (MER) of around 2 per cent will underperform the market by roughly the same amount.
A couple of caveats are required. In Canada, many of those mutual funds do include an advice component that can help investors make decisions. Further, DIY investors are not entirely spared from investment fees. But these days, broad Canadian stock market ETFs have MERs as low as 0.05 per cent. And the rise of commission-free trading is also making self-guided investing ever cheaper for the retail set.
Caveats aside, the track record of active management speaks for itself.
The second big force working against stock pickers is the efficiency of the market. Algorithmic trading and hordes of quantitative analysts, or quants, armed with high-frequency data have become major market participants in recent years.
“We have millions of people trading trillions of dollars long and short, 24 hours a day,” Mr. Shaunessy said. “The idea that somebody sitting in Toronto or Vancouver is going to be able to pick a stock based on something that no one else knows is highly unlikely.”
Pockets of the equity universe, like small caps or emerging markets, are more likely to have inefficiencies that can yield a shrewd investor outsized returns. But these days, global stock market performance is driven by a concentration of enormous tech firms.
And still, the industry promotes the myth of the stock picker’s market, in marketing materials and investment commentaries. “It’s this misleading thing that becomes normalized because it’s said so often,” said John De Goey, a portfolio manager at Designed Securities.
But if there are times that are more conducive to stock picking, then the opposite must also be true.
“You never hear anyone say, ‘You don’t need my services because we’re not in a stock picker’s market’,” Mr. De Goey said.
There are indeed such phases of the market, when it’s especially hard to differentiate oneself from the pack. The onset of the COVID-19 pandemic and then when most pandemic restrictions ended, for example, saw stocks trade with a very high degree of correlation. The vast majority of listings initially tanked, and then rose in unison.
It’s a very different kind of market today. A Cboe index measures the expected correlation over the next six months between the top 50 individual stocks in the S&P 500 index. It normally sits at around 50 per cent. In the pandemic, it cracked 80 per cent. This month, it fell as low as 12 per cent.
If this isn’t a stock picker’s market, perhaps there is no such thing.