Charlie Munger, the vice-chairman of Berkshire Hathaway, has been talking about the difficulties which stock pickers have been experiencing during the current eight year bull market. This is a subject we have covered over the last couple of weeks, the fact that it is proving extremely difficult to cherry pick the best performing stocks and sectors compared to indices which continue to move higher.
Stock pickers have historically been able to cherry pick the best performing areas of the market and take advantage of bull markets by reducing their exposure to substandard performance stocks.
What are the difficulties for stock pickers?
The statistics are there for everyone to see, fewer than one in five stock pickers managed to beat the S&P 500 in 2016. While it is dangerous to take short-term statistics in isolation this fact has not gone unnoticed by private and corporate investors. As a result there has been a massive inflow of money into exchange traded funds which effectively mimic and follow the general performance of indices. To give you an example, less than 10 years ago there were just a few hundred billion dollars invested in exchange traded funds but today that figure is $2.7 trillion.
The current environment is “unique” to say the least therefore we are not able to compare and contrast historic index and sector performances. We have a low interest rate environment which makes high yielding stocks particularly attractive, growth stocks are able to borrow at competitive rates and the property market continues to go from strength to strength. Therefore, from a stock picker’s point of view there is not always an obvious area or stock to focus on.
Fees under pressure
As exchange traded funds simply track a chosen index they are very easy to manage and much of the hard work is done by computer programs. Therefore it will be no surprise to learn that these operations can function on small margins because of their relatively low running costs, compared to traditional stock market advisers. This in turn has prompted stock pickers and more traditional advisers to reduce their fees.
While investors may appreciate the reduction in fees, this can often starve research departments of much-needed capital. In what can become a self-fulfilling prophecy, a reduction in research department investment will ultimately impact a stock-pickers performance placing yet more pressure on fees. It is very easy to see how a pattern might begin to emerge and ultimately more investors could look towards exchange traded funds for their simplicity.
Might this prompt high risk strategies?
In what could become a very unfortunate side-effect from the continuous pressure on fees, we could see some stock pickers perhaps consider more high-risk strategies as they become more desperate to beat the market. This is all good and well when everything is going to plan but high risk strategies will sooner or later hit choppy waters. It is also worth considering the fact that many investors will turn away from high-risk strategies, even if there were successful, because of the concern that one day the strategy will falter.