There’s a rally beginning in stock picking, and it’s being led by Wall Street rookies.
That’s the conclusion of Bank of America Merrill Lynch, which says financial advisers are putting more emphasis on choosing individual stocks instead of moving money to exchange-traded funds and passively managed funds. It’s a modest reversal of a longtime trend.
Jill Carey Hall, an equity & quantitative strategist for BAML, says the change comes after an unusually strong year for those funds.
“2018 was a decent year for active funds, it was one of the better years this cycle,” Hall said. She added that with competition from ETFs and passive funds rising, fees for active management are coming down.
The market’s turmoil last year may have contributed to the shift. Actively managed funds tend to do best when the market isn’t doing as well, while passive funds tend to look best when the market is rallying in a broad way.
BAML surveyed 505 financial advisers in January and found that on average, they had 40% of their holdings in individual stocks, up from 37% the year before. It also says readership of its own reports on individual stocks jumped 5% in 2018 after falling for the previous two years.
Hall said that another important shift in the market might also be adding to the appeal of stock picking: there is now more differentiation within individual market sectors, such as Microsoft or Apple in the technology industry, than there is between separate industries such as tech and health care. That makes fine points like company cash flows and profit margins more important.
“For the first time since 2011, stock differentiation within sectors has become more heightened than sector differentiation,” she said. “That supports fundamental investing.”
BAML’s survey found that the main reason for the shift toward stock picking was that advisors with less experience and fewer assets put more money into on individual stocks.
“This year marked a big shift in less tenured advisors with smaller pools of assets increasing stock allocations — from ~30% in 2018 to close to 40% today,” wrote equity and quantitative strategist Savita Subramanian and Hall in their report.
It’s a noteworthy change because purchases of ETFs have been rising and stock purchases have been falling for years. Investors have been drawn by both the performance of ETFs and passive funds and their lower fees. This chart by BAML shows that more than 40% of US funds are now managed using passive strategies, more than double the total from a decade ago.
The less-tenured group had fewer than 11 years’ experience and they managed less than $100 million in assets on average.
The entire group of advisers was fairly optimistic about the market: 66% of them think stocks will peak in 2020 or 2021, and only a small minority felt that the S&P 500 won’t be able to surpass its September 2018 high.
Overall, the fund managers BAML surveyed allocated 59% of their portfolios in stocks. That was down slightly from the year before, as they shifted slightly toward both bonds and cash.
But the analysts aren’t convinced the new trend will last. Most US assets are still in active strategies despite the recent shift toward passive investing, they say, and it’s possible that the US will eventually look more like Japan, where some two-thirds of assets under management are in passive strategies.