A new GMO white paper titled Is Skill Dead? notes that only 17 per cent of US large-cap managers met or exceeded the S&P 500 over the 12 months to 30 September 2014.
“Between 80 per cent and 90 per cent of active US equity managers will have underperformed their benchmark this year, making it one of the worst years for active management in the recent past,” said the paper.
However, there are a number of factors at play in 2014 that made US active managers’ lives particularly difficult, said GMO.
Non-US stocks, US small-caps and cash all significantly underperformed the US equities market in 2014, said the paper.
“It is not uncommon for managers to have several percentage points of their portfolio allocated to each of these asset classes, and therefore underperformance from any of these will act as a drag on the performance of the overall portfolio,” it said.
If a manager were to have five per cent of their portfolio in non-US stocks, five per cent in small/mid-cap US stocks and one per cent in cash they would have started with a deficit of 120 basis points versus the index, said GMO.
“That is a lot of ground to make up from stock picking within the S&P 500 alone,” it said.
“For active management as a whole, 2014 was a year when the forces in our three-factor model were aligned in such a way as to make it an especially difficult environment for active managers to outperform.
“US equities trounced non-US equities, large-cap stocks trounced small-cap stocks, and equities trounced cash. That was a lot of trouncing going on. And, sure enough, active management was trounced,” GMO said.
But investors cannot allow the results of 2014 to dictate the merits of active investing versus passive investing, said GMO.
“Active management allows for the continuous assessment of the state of the market and to make intentional choices about how best to take advantage of opportunities and mitigate risk,” said the paper.
“Reacting to the short-term pain of underperformance and locking in a loss may feel good but can be very costly.
“It is unlikely that 2015 will result in the same performance for active managers as 2014. It is certainly possible, but we think it is unlikely,” GMO said.
