Fund managers need to buy stocks of high-quality major companies if they hope to beat the major stock indexes this year, a Wall Street strategist said.
That’s the best way to bounce back from the worst year for actively managed funds in at least a decade, according to Savita Subramanian, equity and quant strategist at Bank of America Merrill Lynch.
In 2014 “just 19 percent of large-cap managers beat the Russell 1000, with the average fund lagging by 2.4 percentage points,” she said in a January 7 report obtained by MoneyNews. “Only 2010 and 2011 were similarly poor, when 20 percent and 21 percent of managers beat the benchmark.”
The Russell 1000 Index rose 11 percent last year for the lowest gain since 2011. The index
is made up of companies with a weighted-average value of $122.8 billion, the largest being Apple Inc. with a current market capitalization of $652 billion.
Active investment strategies select securities based on criteria such as estimated earnings growth and relative value, while passive strategies track a benchmark of securities such as the S&P 500 Index or the Barclays Capital U.S. Aggregate Bond Index.
Subramanian said the problem with actively managed funds is that they all owned similar stocks that quickly reached full valuation, a phenomenon known as “crowded trades.”
“The most crowded stocks underperformed the most neglected stocks by a whopping 32 percentage points last year,” she said. Active managers didn’t anticipate a drop in interest rates that drove investors into stocks with stable dividends, such as utilities, which rose 29 percent on average.
While large-cap stocks outperformed small-cap names last year, bigger companies have more room to outperform in 2015, she said.
“Despite the perception that small caps are due for a bounce, small caps have historically continued to lag large following years of similar underperformance,” Subramanian said. “We and our small-cap team expect this will be true in 2015.”
Large-cap companies offer value and stability compared with smaller companies, according to her estimates.
“Small cap valuations are still slightly expensive relative to large caps,” she said. “If volatility picks up, interest rates rise and credit spreads widen, these may be headwinds to small caps which are typically more credit-sensitive.”
Bob Doll, chief equity strategist at Nuveen Asset Management, said it may become tougher for investors to make profits this year unless they are selective, but that the stage is set for more gains.
He said that among U.S. stocks, he prefers mid-cycle cyclicals, companies that generate positive free cash flow and stocks with higher levels of domestic earnings.
"Even though equities are likely to advance further, the pace of gains that occurred during the massive run-up since the 2009 market low is likely to falter. We are expecting to see average annual returns somewhere in the mid-to-high single digit range," he wrote in an investment commentary
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