Lover the year falling markets left few investors smiling. Stocks and bonds fell alike; haven funds failed to offer a safe haven. Doing well meant a single digit percentage loss rather than double. So it may be a strange time for asset managers to be walking with a spring in their step.
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But on January 23 it emerged that Citadel, a secretive investment firm based in Miami, had generated $16bn in net profits for its clients in 2022, breaking the record for annual profit largest in dollar terms. His main hedge fund returned a 38% return – while it was mscThe broadest index of global stocks fell 18%. Champagne corks appeared elsewhere too. Strategas Securities, a brokerage and research firm, estimates that 62% of active fund managers investing in large US companies beat the s&p 500 index of these shares in 2022, the highest percentage since 2005.
So last year there was a huge loss for stock pickers. Every year from 2010 to 2021, more than half of active managers measure their performance against the s&p He failed to hit 500. In other words, the average fund manager was issued with a simple algorithm blindly buying all the stocks in the index. Algorithms like this – known as “passive” or “index” money – are taking over. By 2021 43% of their assets were managed by American investment firms, and they owned a larger share of the country’s stock market than their actively managed peers.
The logic that drives passive money is inescapable. By definition, the performance of an index is the average of those who own the underlying stocks. Beating an index is a zero sum game. If one investor does, another has to lose out. Active managers may see a superstar stock that ends up leaving the rest in the dust. But it will also be in the index, so passive investors will buy it too. At the same time, active managers tend to charge fees that are orders of magnitude higher than passive ones: often 1-2% a year, and more for whizzy hedge funds, compared to as little as 0.03% for their co- algorithmic ages. This drag on performance makes it almost inevitable that index funds will outperform human money managers over the long term.
So how will asset managers perform in 2022? One possibility is pure luck. Pick a group of stocks from a random index, subtract a percentage point or two from their return for taxes, and occasionally you’ll have picked stocks that do well enough to beat the average.
A variation of this allows for some skill on the part of the stock picker. At the start of 2022, Alphabet, Amazon, Apple, Microsoft and Tesla accounted for nearly a quarter of the total market capitalization of the s&p 500. Their collection value fell by 38% over the year; the rest of the index fell just 15%. The index was so concentrated that one good judgment – thinking that the shares of the American tech giants were lazy and to be avoided – would have left a stock picker with a good chance of beating the market.
Extending this technology sensitivity to a broader stock valuation concern would give stock pickers a second chance to outdo them. Questioning such things went out of fashion during the years of free money that followed the global financial crisis of 2007-09 and then covid-19. Share prices rose to impressive multiples of the underlying companies’ earnings or assets, and then kept climbing. Those who took that as a sign to avoid them, in anticipation of a correction, lost. Passive money that bought everything indiscriminately prospered, including stocks that seemed overpriced. But in 2022 rising interest rates brought the trend to an abrupt halt. Investors who had hunted for stocks that were cheap relative to their fundamentals were finally rewarded.
For companies like Citadel, a chance to finally prove their worth came from falling share and bond prices. Market crashes and an uncertain economic backdrop are the raison d’être for hedge funds with a mandate to invest in any asset class they choose. It’s much easier to beat stock market indexes that are falling by double digits if you’re not obligated to buy stocks, like the money that tracks the market. And for the shrewdest managers, last year’s crisis looked like opportunity. As the sovereign debt market forced British pension funds into a fire sale in September, Apollo, a private investment firm, began raising funds to preserve a quick profit. Index funds are not going away, nor should they. But just occasionally, active managers are worth their fees.
Read more from Buttonwood, our financial markets columnist:
Venture capital’s $300bn question (January 18)
The dollar could give investors a bad surprise (January 12)
Will 2023 be another terrible year for investors? (January 5)
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