Bloomberg's Lu Wang published a great article this morning documenting the challenges facing active managers in an environment where several mega-cap companies are driving indexes to record highs.
The basic problem is basic mathematics. “Magnificent Seven'' stocks make up about 30% of the S&P 500, and investors cannot hold these stocks in this proportion, so they cannot catch up with the benchmark index by aligning with the benchmark index. . Of course, a mutual fund manager can stuff her funds with an ETF that tracks the S&P 500. But that's not why investors pay the high fees charged by actively managed funds.
At particular issue is the Investment Company Act of 1940, which governs the behavior of actively managed equity funds.
As Morningstar's Robbie Greengold wrote last year, the law “implies that an allocation of more than 5% to a single security is uncomfortably large. To achieve decentralized status, A mutual fund must limit the total share of such positions to 25% of its holdings' assets. ”
Article 5 of this law specifically states:
“Diversified Company” means a Management Company that meets the following requirements: At least 75 percent of the total asset value is represented by cash and cash items (including receivables), government securities, securities of other investment companies, and other securities. For purposes of this calculation, the amount for any issuer is limited to no more than 5 percent of the total asset value of the management company and no more than 10 percent of the outstanding voting securities of the management company. Issuer.
Essentially, funds are mostly liquid and their investments are widely diversified and should remain mostly passive as they relate to the management of the companies in which they invest. And this last part introduces another notable wrinkle in the active fund management community.
Most investors who use mutual funds to allocate their funds probably don't want to become activist investors. But if so, these rules eliminate the possibility of this strategic wrinkle. The world of investing can also be a dangerous place for stock picking.