How Funds Did in Q1 Overall & Vs. S&P 500

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 recent Bank of America Merrill Lynch report.

“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.

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 seven percentage points, which is “an atypically high spread,” they say.

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 two 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.

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