Active bond managers could use more of Bill Gross’s swagger.
No sooner had the hall-of-fame bond manager announced his retirement on Monday than the financial press declared his downfall. The Wall Street Journal headline proclaimed “Bill Gross, Onetime Bond King, Retiring After Messy Last Act,” and another in the Financial Times read “How the ‘bond king’ Bill Gross lost his crown.”
That messy last act refers to Gross’s stint as manager of the Janus Henderson Global Unconstrained Bond Fund since 2014. Gross made some big bets at Janus Henderson that didn’t pay off, most famously a wager last year that rates on U.S. Treasuries and German bunds would converge, resulting in sagging performance for his unconstrained bond fund.
Even though Gross’s calls didn’t turn out the way he and his investors had hoped, Gross was right to bet boldly on his best ideas, and active bond managers would be wise to follow his example.
The pivot to unconstrained investing was a brave departure for Gross, who had spent the previous three decades perfecting the “total return” approach to bond investing with the Pimco Total Return Fund he founded in 1987. The strategy attempts to outpace the broad bond market by taking modestly more risk, often by buying lower-quality bonds than are reflected in broad-market bond indexes while targeting a similar average maturity.
No one did it better than the Bond King. The institutional share class of Gross’s total return fund outpaced the broad bond market, as represented by the Bloomberg Barclays U.S. Aggregate Bond Index, by 1 percentage point annually during his run from June 1987 to September 2014, a huge margin for a bond manager. And he did it with only modestly more risk, as measured by annualized standard deviation (4.3 percent for Gross’s fund compared with 3.9 percent for the index).
Jeffrey Vinik, who rose to fame as manager of the Fidelity Magellan Fund in the 1990s, told CNBC last week that he was getting back into the stock-picking game. He will resurrect Vinik Asset Management, a hedge fund he closed in 2013.
Only this time, Vinik won’t just be competing with the market and other managers. He will also have to outmaneuver the computers that are increasingly displacing stock pickers.
It’s a brave move. Stock pickers have struggled to perform in recent years and investors are abandoning them. Actively managed stock mutual funds have experienced net outflows for five consecutive years, a total of $918 billion from 2014 to 2018, according to estimates compiled by Bloomberg Intelligence. Hedge funds managed to hang on to their assets for most of that period, but after a disappointing 2018, investors are pulling money from them, too.
While others bemoan a profession in decline, Vinik sees a resurgence. “I think this is an incredible opportunity for old-fashioned stock picking,” Vinik told CNBC. “We’ve had decades, maybe 10 or 20 years, of active managers underperforming passive managers.”
It’s fashionable to blame a bad environment for stock picking for active managers’ woes, but it’s not entirely true. Sure, value investing has lagged the broad market over the last decade, but other styles of active management, such as growth, quality, momentum and low volatility, have beaten the market. In other words, active managers have underperformed, not active management.
I know why investors don’t care about Fidelity Magellan’s comeback.
As Bloomberg News reported on Monday, the mutual fund made famous by hall-of-fame stock picker Peter Lynch is enjoying a resurgence after years of mediocre performance. The fund fell into a “15-year funk” after Lynch’s successor, Jeffrey Vinik, left in 1996. But ever since current manager Jeffrey Feingold took over in September 2011, “Magellan has bested the S&P 500 index every full year but 2016.” The fund has also “outdone more than 90 percent of funds with a similar investing style over the past one, three, and five years.”
Despite Feingold’s apparent success, however, investors are yanking money from the fund. The knee-jerk explanation is that investors have lost faith in active management, no matter what the results. A more accurate one is that investors no longer need the vast majority of actively managed funds, including Magellan.
Indexing pioneer Vanguard Group may be stock pickers’ last hope.
Investors are increasingly turning their stock picking over to computers. So-called smart beta exchange-traded funds track indexes that replicate traditional styles of active management such as value, quality and momentum. Investors handed $184 billion to smart beta ETFs from 2015 to 2017 while pulling $308 billion from equity mutual funds, according to data compiled by Bloomberg Intelligence.
It’s not surprising. Smart beta ETFs are cheaper, and investors are skeptical that human stock pickers can beat the bots by more than the difference in fees. According to Morningstar data, the average expense ratio for smart beta ETFs is 0.47 percent a year, and the asset-weighted average expense ratio — which accounts for the size of the ETFs — is just 0.26 percent. That compares with 1.13 percent and 0.7 percent, respectively, for actively managed mutual funds.
Warren Buffett is an even better investor than you think.
The Oracle of Omaha released his latest annual letter to shareholders of Berkshire Hathaway Inc. on Saturday. It’s a good excuse to marvel anew at Buffett’s track record, particularly at a time when stock pickers are losing their aura.
Buffett famously likes to invest in companies that are highly profitable and selling at a reasonable price. That formula has routinely beaten the market, according to University of Chicago professor Eugene Fama and Dartmouth professor Kenneth French.
The Fama/French US Big Robust Profitability Research Index — which selects the most profitable 30 percent of large-cap companies — beat the S&P 500 Index by 1.2 percentage points annually from July 1963 to 2017, including dividends, the longest period for which returns are available. The profitability index also beat the S&P 500 in 81 percent of rolling 10-year periods.
Similarly, the Fama/French US Large Value Research Index — which selects the cheapest 30 percent of large-cap companies — beat the S&P 500 by 2.3 percentage points annually from July 1963 to 2017, and in 82 percent of rolling 10-year periods.