Investors can't afford to be complacent, especially when the stock market is going gangbusters. Now's the time to protect your hard-won gains -- and continue winning.
Many investors have chalked up sizable gains in this bull market by putting their money in index funds, which invest in the components of the major market indexes, such as the 30 stocks in the famed Dow Jones industrial average or the 500 stocks in the most important equities index, the S&P 500. They raked in handsome profits without much effort on their part.
This is what's commonly called "passive investing," where an investor depends mainly on the market's prowess to do the job of winning. These funds are fine -- when the market is galloping and gaining. But when things turn, investors can feel the pain as their index funds start giving up those winnings. What does an investor do then? The astute strategy is not only to hold onto those gains but to continue amassing profits.
Time now to ponder whether the indexes are apt to continue surging or whether the cycle may be turning. The pros who practice "active investing" -- who do not depend on the "passive" pursuit of profits via the market-dependent index funds -- are now advocating "skilled stock picking."
True, few investors have the skills, experience and tenacity to pick stock winners over a stretch of time. And just as true, the pros who pursue a strategy of active investing have sorely underperformed the index funds for years, including last year. This is confirmed by the "S&P Indices Versus Active (SPIVA)" scorecard that has been tracking the performance of active and passive strategies in the U.S. since 2002.
Aye Soe, senior director of global research for the S&P Dow Jones Indices, notes that in 2015, 66.11 percent of large-cap "active managers" underperformed the S&P 500. And such poor performance, according to Soe, occurred even on longer time horizons, extending over five to 10 years.
But there are experienced pros who excel in active investing with their stock picking skills and have achieved tremendous profits for their investors. The answer is savvy stock picking anchored in the fundamentals driving company growth and awareness of the many market factors that can shape growth.
"We believe that skilled active management, backed by in-depth fundamental research, can add value for clients over longer time horizons," says Terry Davis, investment specialist at T. Rowe Price. Focusing solely on short-term relative performance could be a critical mistake, he adds, "as active portfolio strategies may take time to come to fruition."
The stocks that usually comprise the index funds typically don't move in a uniform fashion, underscoring the point that stock picking offers ample reward opportunities. For instance, last Wednesday the S&P 500 rose 9.2 points, or 0.4 percent, closing at a little over 2,173. On the same day, Microsoft (MSFT) gained $2.82 a share, or 5.3 percent, to $55.91, following its report of strong quarterly earnings. And Cintas (CTAS) soared $9.43 a share, or 9.7 percent, to $106.85, after exceeding investors' earnings expectations.
So one thing is clear: Investors who aren't immersed in the ways of the market and stock picking need to seek the help of experienced professionals. Inherent in passive investing is the low cost, as there's no need to retain a pricey research firm to analyze securities in index funds. While active money managers can't match the low fee structure of passive investing, seeking an experienced fund manager with relatively modest fee requirements is important.
Professional stock pickers argue that effective research leads to superior returns compared to those of index funds, and so the cost of having a good research team can more than pay for itself. The key is to engage truly knowledgeable and experienced fund managers who practice active management.
Gregory Warren, senior equity analyst at Morningstar, recently noted that T. Rowe Price has produced impressive revenue growth in its assets under management in the past two decades, "thanks to its strong brand and solid fund management."
An internal analysis was conducted this year by T. Rowe Price after some prompting from clients. It showed that among its array of funds, 18 actively managed T. Rowe Price diversified U.S. equity funds over the 20 years ended in 2015 "generated positive excess returns net of fees, versus their designated benchmarks over rolling 12-month periods, and over 3- and 5- and 10-year periods," says T. Rowe Price's Davis. And he points out that the excess returns usually get even better when investors invest for the long haul.
A recent Morningstar report on "25 Funds Investors Are Buying" shows that one of the nine T. Rowe price funds that recorded excess returns over rolling 10-year periods is the T. Rowe Price Blue Chip Growth Fund (TRBCX), which is rated a five-star performer that attracted nearly $2.6 billion in new assets over the past year. And as of July 6, 2016 (the date the Morningstar issued its report), the Blue Chip Growth Fund had total assets of almost $31.6 billion.
"We strongly believe that skilled, risk-aware, active management has the potential to add value over longer-term time horizons," says T. Rowe Price's Davis. As active equity managers, "we are primarily interested in whether our own investment process has created long-term value for our clients," he adds.
Six other T. Rowe Price funds that boast impressive 10-year scores and are accessible to individual investors are the T. Rowe Price Growth Stock Fund (PRGFX), New Horizons Fund (PRNHX), Capital Appreciation Fund (PRGFX), Mid-Cap Growth Fund (RPMGX), Small-Cap Stock Fund (OTCFX) and New America Growth Fund (PRWAX). Two other funds that have amassed impressive records are designed for institutional investors: T.Rowe Price Institutional Large-cap Value Fund (TILCX), and the Large-Cap Growth Fund (TRLGX).
These funds' consistently superior performance demonstrate that there are, indeed, active managers capable of steadily outperforming passive strategists for extended periods of time.
So for investors getting edgy over future returns, a good place to look is the tight universe of professional stock pickers who have produced consistently superior performance through many years of extraordinarily skilled stock picking prowess.