Index funds and passive investing is the topic du jour lately. And for good reason. Active fund management has performed poorly over the past several years -- against a strong bull market. To be fair, active managers have little recourse here: when the market triples over seven years and active funds fall grossly below that, their value to investors must be questioned.
Still, I don't believe stock picking is dead at all (neither does Jim Cramer, who writes about this topic today on Real Money). Names such as Seth Klarman, Mason Hawkins, Ted Weschler, Wilbur Ross, Carl Icahn, Howard Marks, Bill Ackman and John Malone are evidence of that. What I believe has become flawed, however, is the process of stock picking.
First, active managers have become too short-term oriented. Stocks have never been a get-rich-quick scheme. Equity value growth is most powerful when allowed to compound over time. Yet many active funds fail to behave like a long-term investor. While someone like Bill Ackman may be getting hounded over his bet on Valeant Pharmaceuticals (VRX) , over his career, Ackman's fund has delivered value for investors.
Secondly, many active funds are simply too expensive. Picking stocks is not an expensive endeavor; it requires diligent analysis and a trade. But after taking asset management, marketing or other non-performance related fees, these funds are starting off handicapped against the market.
Vanguard founder John Bogle has observed that nearly 85% of actively managed funds fail to beat the S&P 500. I would imagine if active funds were compensated on performance vs. asset collection, perhaps the numbers would be different.
Finally, and perhaps most ironic, is that most active funds actually behave like herds. And when you behave like everyone else, how is it possible to do better than average? For years, everyone had to own Apple (AAPL) . Today, it's not Apple but the FANG (Facebook (FB) , Amazon (AMZN) , Netflix (NFLX) , Alphabet/Google (GOOGL) ). To beat the market you cannot be like the market or everyone one else. (Apple, Facebook and Alphabet are holdings in TheStreet's Action Alerts PLUS portfolio.)
So stock picking is not dead, but unfortunately, thanks to growing fees and bad processes, active performance has suffered. And as you would expect in a free capitalistic market, money is going to flow where the results are. The Wall Street Journal reported that over the past five years more than $1 trillion has been moved into passively managed funds while hundreds of billions have been pulled out of active funds.
If active performance continues to lag that trend will surely continue. Yet, stock pickers who don't fall prey to the collective noise can still shine and do exceedingly well.