In the normal course of events, as stock market volatility increases, stock pickers get more opportunities to exploit temporary pricing anomalies for profit. Nonetheless, despite a 50% surge in the CBOE Volatility Index (VIX) in 2018, noticeably fewer actively managed large cap mutual funds managed to outperform the S&P 500 Index (SPX) than in 2017, per data from Bloomberg reported by Business Insider (see below).

Stock Pickers Are Getting Trampled

  • 2018: 35% of actively managed mutual funds outperformed S&P 500
  • 2017: 42% of actively managed mutual funds outperformed S&P 500

Source: Bloomberg, as reported by Business Insider

Significance For Investors

While bigger price swings theoretically produce more chances for short-term speculators and active fund managers to profit, the challenge is picking the right stocks at the right prices at the right times. Even the most rigorous fundamental analysis aimed at uncovering undervalued stocks only will bear fruit if the rest of the market agrees and subsequently bids their prices upwards. Anticipating how the rest of the market will react is part of the challenge for stock pickers.

Additionally, all companies are subject to macro forces that are largely, if not completely, beyond their control. These include the state of the general economy, shifting consumer preferences, government policy, political upheavals, and the weather, to name just a few. Some observers argue that such macro uncertainties were especially elevated in 2018, making successful stock picking particularly difficult last year. Among the biggest uncertainties were, and continue to be, related to President Trump's trade wars and monetary tightening by the Federal Reserve.

The inevitable result of underperformance by active investment managers was to spur a flight to passive management by disappointed investors. During the 12 months through November 2018, active equity funds saw an outflow of more than $180 billion, per Morningstar, as reported by Business Insider. Meanwhile, passive investment vehicles enjoyed an inflow of more than $320 billion in the same time frame. The iShares family of ETFs offered by BlackRock posted record monthly inflows in each of the last two months of 2018.

Looking Ahead

The rush to passively managed funds presents dangers of its own. Critics warn that this creates increasingly crowded investments in popular stocks, and that it tends to push up valuations in segments of the market that already are pricey. When investors lose confidence and decide to head for the exits, an avalanche of selling can send prices plummeting, spurring yet more waves of selling.