While the hedge fund community has once again failed to take advantage of what so many predicted would be a new "golden age" for the 2 and 20 crowd as a result of a collapse in pairwise correlations, largely as a result of short stocks squeezing higher and hurting performance, it has been a different story for the "long only" mutual fund group, which according to a new analysis by Bank of America enjoyed its best quarter and 1H half in eight years, specifically "over half (54%) of large cap fund managers beat their benchmarks in the first half of the year- for the first time since 2009."
Much of this outperformance was helped by positioning in just three sectors: managers were overweight in the best-performing sectors in the first half: Discretionary, Health Care and of course, technology.
Some more details:
June marked the fourth consecutive month where most large cap managers (52%) beat their respective benchmarks - the longest streak of above-50% hit rates in our data history going back to 2009. In the second quarter, 60% of the managers outperformed their benchmarks, the highest hit rate since 1Q 2009, and one of only six quarters in which over half of fund managers outperformed their benchmarks during the quarter (Chart 1). In 1H, 54% of large cap fund managers outperformed their benchmarks - the first time in our data history where more than half of managers beat their benchmarks in the first half of the year. This outperformance was largely driven by style funds, as 71% of Value managers and 64% of Growth managers beat their respective benchmarks in 1H, compared to just 36% of Core managers.
While the abovementioned growing de-correlation trend appeared to end in May, when single-stock pairwise correlations to the S&P reverse, it was still sufficient to help out the mutual fund industry. As BofA notes, "average pair-wise correlation of stocks in the S&P 500 sharply reversed its decreasing trend in May, but still remains way below the long-term average. Small cap correlation now converged to the long-term average. Higher correlations make it difficult for managers to navigate the macro driven market." Unfortunately for hedge funds, while their long books enjoyed the trend, their short positions in many cases offset any gains on the long side.
On the other hand, return dispersion for large caps has once again dipped in June towards the record low, making it more difficult for managers to generate alpha. Dispersion between the top and bottom performing quintiles rose slightly for small and mid caps. It remains to be seen if the withdrawal of trillions in excess liquidity will lead to a substantial spike in this indicator, which is so critical for the active investor community to return to their alpha-generating ways.
But ultimately, it was one specific factor that provided the biggest boost for mutual funds: their overexposure to tech stocks and momentum:
Sector positioning appears to have been a big contributor to managers' best post-crisis hit rate. Managers have remained consistently overweight in the best-performing sectors in 1H - Tech, Discretionary and Health Care - with a record-setting overweight in Tech (which was +17.2% in 1H). Managers have also set record low underweights in Staples, Utilities, and Telecom, all of which have underperformed so far this year. The drop in the average pair-wise correlation of the S&P 500 may have also helped stock picking this year.
Of course, now that techs are in retreat, the golden age for mutual funds may be coming to a close. It remains to be seen if hedge funds can finally step into the performance void and capitalize.