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Boston Capital

Stock pickers need years to regain trust

Nobody loves them.

The stock pickers of the mutual fund world — once the rock stars of finance — couldn’t sell popcorn at the circus today.

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In fact, that’s been the case for years now, and investors have pulled hundreds of billions of dollars out of domestic stock mutual funds since 2006. This trend has gone on for so long — and built up such a big cumulative financial punch — you have to wonder what it would take to reverse the pattern.

It would be easy to blame the fate of the active US stock fund manager on a perfect storm of terrible equity markets and aging demographics that favor more conservative investments. Those are legitimate factors behind the shareholder exodus. Big money moved into bond funds while stock pickers fell out of favor.

But investors don’t simply have an aversion to US stocks. They are more likely to entrust any new money earmarked for domestic equities to passive index funds rather than active managers who rely on skill and research to select investments. The dismal big picture on customer cash flow in and out of all domestic stock funds – a collection of weekly industry reports – actually masks even worse trends among active managers.

Consider the direction of net flows – the balance of investor money sloshing in and out of funds – so far this year. All domestic stock funds saw a net outflow of about $34.1 billion during the first five months of this year, according to Morningstar Inc.

Now look closer at the numbers. Outflows for active managers actually totaled $40.2 billion, while index funds attracted $6.2 billion of net customer money. This pattern of big money leaving actively managed domestic stock funds as more modest amounts moved to index funds has held true since 2006.

In that time domestic stock index funds have pulled in about $150 billion of customer cash, while actively managed funds in the same category have lost $516 billion — yes, a half-trillion dollars!

The growing advantage of passive US equity investments over active managers would appear even worse when you add exchange traded funds, or ETFs. They are investments that trade throughout the day, much as a stock does. But most own fixed portfolios based on market benchmarks, just like passive index mutual funds.

I’ve kept most ETFs out of the calculations because a large chunk of those shares is sold to hedge fund managers and other pros who would never consider buying actively managed mutual funds. One exception: Vanguard Group’s $200 billion ETF business is counted among index mutual fund assets.

So, what would it take to make stock fund managers win back investors? Certainly they need a shift in the stock market itself, and that means two things.

First, investors need to see markets that give them some confidence stocks will produce steadier gains. The stock market of the past 12 years has paid shareholders about 1 percent annually to endure a volatile and sometimes harrowing ride. Individual investors need a good reason to buy stock funds.

“We’ve got a lot of damage to repair as active managers,” notes Geoff Bobroff, a fund industry consultant.

Also, stock markets need to move in ways that make a manager’s judgment worth something. In recent times, stocks have moved up or down almost unilaterally. Nearly all climb or fall together — for days or weeks — based on a consensus opinion about economic risk. The value of a manager’s selecting individual stocks becomes negligible when the vast majority of shares move in tandem —regardless of the relative values of companies. That has to change.

This prescription is easy to write but more challenging to pull off. It relies on an economy that continues to recover and lift most companies. It needs investors who believe they can pick companies and industries that will benefit most in a complicated global market.

It would take several years to make a real difference. Bobroff thinks it might require at least three years of better times.

“That’s a long time,” he points out.

But that’s what it is going to take.

The red herring

The Securities and Exchange Commission has temporarily suspended the trading of shares of Apogee Technology Inc., citing the Norwood biotechnology company’s apparent failure to file routine public financial reports. The SEC said Monday that Apogee has not filed quarterly financial reports since June 30, 2011. Apogee officials could not be reached for comment yesterday.

Steven Syre is a Globe columnist. He can be reached at
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