Fund managers are underperforming.

Analysis of mutual fund performance finds that less than one in five large-cap mutual funds outperformed the S&P 500 in the first quarter in 2016.

This represents “the lowest quarterly hit rate in our data history spanning 1998 to today,” according to a Bank of America Merrill Lynch report released Monday.

“The average fund lagged by 1.9 [percentage points], marking a record spread of underperformance,” explained equity and quantitative strategist Savita Subramanian and colleagues at Merrill. “And growth funds, for which our data extends further back, saw a 6% hit rate, the worst since at least 1991, with the average fund lagging by the widest margin we have recorded in our quarterly data: -3.5 [percentage points].”

Value managers had a better hit rate, the report says, with 19.6% topping their respective index for the quarter. Plus, 29% of core funds did so.

March results, though, “were the worst in a string of months,” the report adds. Large-cap managers’ hit rates for topping the index dropped from 34% in January to 27% in February and then 21% in March.

What’s the Problem?

The Merrill strategists point to a few factors that appear to be contributing to fund managers’ “recipe for distress.”

“Heightened correlations … and low alpha opportunity … continued to hurt, as stock selection thrives when intra-stock correlations are low and alpha is abundant,” they explained.

However, it’s also true that these contributors to underperformance have been around “for a while.”

Instead, the report authors believe “the lit match taken to active returns last quarter was likely the massive reversal – by the market, by sectors, by styles and by stocks – occurring within the quarter.”

First, momentum investors found that “almost nothing worked during both halves of the quarter except valuation,” according to the report authors.

Second, crowded positions proved to be “particularly damning” in Q1: The 10 most popular stocks underperformed the 10 most neglected stocks by almost 7 percentage points, which is “an atypically high spread,” they say.

Other Results

The quarterly results for small-cap managers topped their mid- and large-cap counterparts, with more than 80% of core small-cap funds topping the Russell 2000 Index and average excess performance of over 2 percentage points.

In value, 68% of these small-cap funds topped the index, and the average fund outperformed by 92 basis points, despite being underweight in top sectors like utilities and REITs, the Merrill study finds.

“With high quality continuing to outperform year to date, small-cap active managers have benefited given their high-quality bias – the opposite of large-cap managers,” Subramanian and team explained.

“Biotech tanking 32% this year helped growth managers, who are underweight the group – but still only 47% of growth funds outperformed,” they stated. “Small-cap funds struggled in March to keep pace with their bogey. Value funds (+8.3%) performed in line with the Russell 2000 Value, while more than 60% of core and growth funds trailed their index.”

Mid-cap funds are struggling, with just 13% beating the index and the average fund down 2.1%.

“Core [mid-cap] funds are trailing their index by the smallest spread (78 basis points) with 41% outperforming; only 26% have been successful in value,” the Merrill strategists said.

In March, only 24% of mid-cap value funds outperformed the Russell Midcap Value Index versus about half of both mid-cap core and growth funds.

— Check out SIFMA, IAA Balk at SEC Plan to Limit Derivatives in Mutual Funds on ThinkAdvisor.