Why your fund manager can’t beat today’s stock market

In theory, active fund managers, who try to pick the best investments and avoid the worst, should excel when some stocks zig as others zag and when the gap between the winners and losers is wide.

By some measures, that’s the kind of market we’re in right now. An index of implied correlation from Cboe, the Chicago-based exchange, suggests that the extent to which stocks move up and down in unison is near record lows.

Meanwhile, as my colleague James Mackintosh recently reported, dispersion—a measure of how widely the returns of individual stocks differ from the average—is abnormally high.

If stocks are moving up and down together much less than usual, and the winners and losers are even farther apart than normal, that should be ideal for stock pickers.

Instead, active funds are struggling. That pokes a hole in one of Wall Street’s most cherished narratives—namely, that it’s worth paying a premium for active management and that stock pickers are sure to do better at some times than at others. The funds’ travails are a reminder of a basic rule: The asset-management industry depends more on marketing than on markets.

For starters, despite this purportedly ideal investing environment, stock pickers are doing even worse than usual. In the first half of 2024, according to Morningstar, only 18.2% of actively managed mutual funds and exchange-traded funds that compare themselves to the S&P 500 managed to outperform it.

That’s down from 19.2% in the first half of last year and 19.8% in all of 2023. Over the past decade, an annual average of only 27.1% of actively managed funds benchmarked to the S&P 500 beat it.

There are a few reasons why stock pickers are stinking up the joint worse than they normally do.

Correlation—that measure of whether stocks are moving up and down together—might not be as low as the Cboe index would suggest. That’s partly because correlation can be measured in different ways.

At my request, Jeremy Raccio, a senior portfolio manager at UBS Asset Management, analyzed correlations within the S&P 500 back to early 2000—using realized returns, rather than the implied volatility (a measure of fluctuation) that Cboe uses.

Although stocks have recently been moving somewhat less in sync than they were in 2022 and 2023, the difference is well within historical norms, Raccio found. Across the entire index and among the largest 50 companies, he found that the stocks are moving together about as much as usual.

“It looks mostly the same, honestly, no matter what period you look at," he says.

Data from Dimensional Fund Advisors also indicates that correlations among stocks are near historical averages.

One implication: Asset managers like to cite whatever data can best bolster their narrative. Stock pickers are all too happy to quote statistics implying that stock pickers should do well.

None of this can hide the howlingly obvious: Active managers are underperforming because they can’t outperform today’s market.

As of this week, the three largest stocks in the S&P 500 — Microsoft, Apple and Nvidia—made up nearly 21% of its total market value. The five biggest stocks accounted for 27%, and the top 10 amounted to more than 36% of the total.

Part of the traditional job of asset managers is to try to control risk, and concentrating that much money in so few stocks is a violation of that principle. Many clients would fire any fund manager who plunked more than one-fifth of their money into only three stocks.

A mutual fund so heavily concentrated in its top few holdings would also be not far from the point at which federal regulators would no longer regard it as diversified.

Actively managed U.S. stock funds have an average of 14.2% in their top three holdings and 20.8% in their top five, according to Morningstar, well below the concentration of the S&P 500.

The market’s biggest companies have gotten so big, of course, because they’ve hugely outperformed everything else.

That means dispersion, which tracks how far the returns of individual stocks differ from the average, has largely become a measure of a handful of winners against hundreds of laggards.

The rest of the market looks like the polar opposite of those few giant technology stocks. In the second quarter of 2024, as big tech drove the S&P 500 up 4.28%, the Russell 2500 index—which tracks small and midsize stocks—was down 4.27%.

Nvidia alone accounted for nearly one-third of the S&P 500’s total return in the first half, according to S&P Dow Jones Indices. Throw in Microsoft, Amazon.com, Meta Platforms and Eli Lilly, and 55% of the market’s return came from just those five stocks.

That means traditional measures like correlation and dispersion have lost much of their meaning and nearly all of their relevance. The 10 biggest stocks own the market right now, and anyone who doesn’t own them is left out in the cold—at least for the time being.

Portfolio managers can talk all they want about how it’s becoming a stock picker’s market. But, unless they picked exactly these stocks—and unless they picked massive quantities of exactly these stocks—they aren’t going to outperform anytime soon.

Fund managers flinging around statistics can’t change that cold, hard fact.

Write to Jason Zweig at intelligentinvestor@wsj.com