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Most Active Funds Trailed Benchmarks in Q3: BofA

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What You Need to Know

  • Only about 42% of active funds beat their benchmarks in Q3, on track with quarterly averages.
  • A similar percentage are ahead year-to-date, a better showing than in the past three years.
  • In September, active funds tended to be underweight energy and stocks that benefited from rising inflation.

Large-cap active funds largely performed in line with their benchmarks in September, outperforming by 1 basis point on average, BofA Global Research reported Monday. Volatility returned in September, with a 40% jump in the VIX as the S&P 500 posted a 4.7% loss, its worst month since March 2020.

For the third quarter, 42% of funds finished ahead of their benchmarks, largely in line with the quarterly average. A similar percentage of funds are ahead of their year-to-date benchmarks, putting performance on track for the best year since 2018 and well above the 28% in 2019 and 34% in 2020.

Active Funds

A big drag on active funds’ September performance was their 16% underweight in inflation beneficiaries — stocks with the highest inflation betas — which outperformed the S&P 500 by four percentage points. 

Active funds were also more than 20% underweight energy, which was the only positive sector during the month as it outpaced the index by 14 points. With Europe’s energy crisis amid tight commodity markets, BofA’s commodity strategists expect that a cold winter could potentially push Brent prices past $100 a barrel.

This could further drive energy and inflation beneficiaries higher and ultimately hurt active funds’ performance, according to the report.

The report noted that volatile markets are often perceived as a good environment for active funds, but an equivalent proportion of funds have historically outperformed in high- vs. low- volatility environments, as well as in rising vs. falling volatility environments on average. 

Moreover, following September’s broad-based selling, alpha opportunities within the S&P 500, spread between the best and worst performing stocks, fell to near historic lows, indicating a tough environment for stock pickers. 

But with third-quarter earnings season imminent, bigger performance divergence may be in the offing, the report said, especially as hot topics such as inflation, supply chain issues and China exposure could further divide winners and losers going forward.

Although September was just an average month for the long-only cohort, it was a good month for hedge funds, as all five strategies BofA tracks beat the S&P 500. 

The report said that unlike mutual funds, hedge funds have historically outperformed during high/rising volatility periods. Equity hedge funds outperform more than 50% of the time when the VIX index was above 20, versus just 33% when the index is below 20. 

And during down months for the S&P 500, 84% have outperformed, compared with only 17% during positive months.

Small- and Mid-Cap Funds

Small cap funds are on top of their game this year. Eighty-three percent of funds are ahead of their Russell 2000 benchmarks for the year to date, and 62% surpassed benchmarks in September. 

Mid-cap funds are also doing well, with 55% ahead of their Russell Midcap benchmarks for the year. September was particularly strong for mid-cap managers, with some three-quarters outperforming during the month. 

Quantitatively focused funds had a tough September, with only one in five hitting their Russell 1000 benchmarks. However, for the year to date, three-quarters are ahead of their benchmarks.

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