Here’s a cause for very modest celebration in downtown Boston: Stock pickers across the mutual fund industry are outperforming autopilot alternatives like index funds and exchange-traded funds this year.
As a leading financial center, Boston was built on active money managers in the mold of Peter Lynch and Ken Heebner. But we’ve been steadily undermined for the past decade by the rise in popularity of passive alternatives built by companies such as Vanguard Group to mimic indexes like the Standard & Poor’s 500.
The really scary part for active mutual fund managers who work at Fidelity Investments, Putnam Investment, MFS Investment Management, and many other shops in town? The sales gap between active and passive mutual funds has never been wider.
As of April, a rolling 12-month sales calculation by the research firm Morningstar Inc. showed that investors had put a net of more than $159 billion into passive domestic stock funds. Actively managed funds invested in the same kinds of stocks saw a net of $151 billion walk out the door during the period.
Stock pickers were badly outperformed by indexers last year, with their average return falling well short of the S&P 500 return of 13.7 percent. Active managers have consistently trailed the index over the past decade, and last year was worse than most others.
So a good start to 2015 is much needed. The active fund manager had earned 4 percent through May, nearly 1 percentage point better than the index. But it’s going to take a lot more than that to persuade investors to do something different with their money.
The sales pitch for passive investments is simple and persuasive. The key is very low fees, which are possible because they are very inexpensive to run. Active stock managers need to earn their fund management fees — typically about 1 percent versus 0.17 percent for Vanguard’s S&P 500 fund — before they can even think about outrunning the market’s benchmark. Over the long term, most can’t do it and the average investor has a very hard time identifying the minority who will beat the market in the future.
Boston had become a mutual funds hotbed at a time when investors had a very different mind-set. They gave their money to star investors — none more famous than Lynch at Fidelity — and believed those managers could indeed beat the market.
But that really was a long time ago. I visited with Lynch recently and he had just marked the 25th anniversary of his retirement as manager of Fidelity Magellan. Once the face of the entire industry, I wonder how many investors know who he is today.
I didn’t hear any broad defense of the active fund management world from Lynch, who remains at Fidelity as a vice chairman and a mentor to younger investment professionals there. His message is all about Fidelity: We can still do it and we’ve proven it.
There is some truth in that. A significant number of Fidelity stock funds have beaten their market benchmarks, which are sometimes different than the S&P 500. Fidelity itself has published research suggesting market cycles are shifting to favor active managers in general.
But you wouldn’t catch a hint of any of this from the company’s recent sales performance. Fidelity has seen money go out of its domestic stock funds in nine of the past 12 months -- more than $17 billion all together, according to Morningstar.
So what would it take for investment companies to entice investors to buy actively managed mutual funds again. I can think of three things that would make a difference:
■ Higher interest rates. Fund mangers complain that the stocks of nearly all companies, regardless of quality, move together when borrowed money is so cheap. Good stock pickers could have a better chance of standing out if rates went up. Most rates have been moving higher this year and further increases are expected.
■ More market volatility. Nimble stock pickers should do better than indexes in periods when stocks move up and down. Active funds should also benefit from cash in their portfolios when the market goes down.
■ A revival of the fund star system, names customers could recognize as standout managers. Investment firms once worried business would leave if their stars quit, so many turned management into faceless teams that emphasized process over skill. Good luck selling that now.
But passive investments have come to dominate new business activity in the mutual fund business for good reasons. Simple solutions that come close to market-matching results are no-brainers for most people. Over time, those much lower fees will help them prevail over most of the active competition.
Those active managers won’t and shouldn’t disappear. Some customers, like me, have the time, resources and hubris to believe we can find the best people to run our money. But we are an increasingly tiny part of the mutual fund world.