Several commentators on Bloomberg TV have attributed significant force in the recent rally to short covering and to nervous active mutual fund and pension fund managers whose compensation (and in severe cases, jobs) are at risk if they under-perform the market on a short-term basis.

There is no question that most active managers are compensated in part based on performance relative to market benchmarks, and that their continued employment is contingent of not falling too far behind for too long.  The greater the expense ratio of the fund, the greater the stress they feel as they try of make out-performing selections to overcome their built in under-performance due to expenses.

Let’s look at some data to see how fund managers have performed over the last 20 days, and how plausible the “nervous managers” explanation for part of the rally may be.  This is a crude measure, but somewhat illuminating.

We measured the ratio of the 200-day simple moving average to the same average 20 days ago (1 month ago) for 4,795 mutual funds of all sorts, including bond funds.

Important data limitations: It would be preferable to look at equity funds only, but we didn’t have that breakdown in the MetaStock database and weren’t ready to sort thousands of funds one-by-one.  The data also included multiple share classes of the same fund — far from cleaned up data.  Additionally, thousands of  funds are not included in the MetaStock database, including very large funds such as those from Vanguard.  Some of the funds are small and some are large, making equal weight in the consideration, well less than ideal.  Nonetheless, with those important caveats,  we did what we could with what we had and think (hope?) the results are probably roughly meaningful.

We found that 333 funds (6.9%) had an upward slope to the 200-day average over the last 20 days, while 4,462 (93.1%) had a downward slope.  Those with an upward slope are overwhelmingly bond funds.  The average fund was downward sloping with a current 200-day average 3% below its level 20 days ago.

Looking for those that are straddling Up and Down direction, there are 1,506 (31.4%) with a current 200-day average between 2% above and 2% below its value 20 days ago.  That left 23 (0.4%) with a 200-day average more than 2% higher than its value 20 days ago, and 3,266 (68.1%) with a 200-day average more than 2% below its value 20 days ago.

There were also 37 funds (0.8%) whose 200-day average was more than 10% below its value 20 days ago (the worst, a Canadian energy fund, was down 22.2%).  There was only 1 fund (a leveraged China equity fund) whose 200-day average was more than 10% above its level 20 days ago (above by 20.1%).

Of the 23 funds that were ahead at least 2% in terms of their 200-day average over one month, almost all were emerging equity funds, but also included a leveraged S&P 500 fund, a leveraged commodities fund, and a few active asset allocation funds investing in both stocks and bonds.

Of the 37 stinkers, all were equity funds.

Conclusion:

It’s tough to outsmart the market, and the average 3% performance gap is probably disturbing enough to cause fund managers to pile on to catch up.  Presuming they piled on early to late mid-rally, they need a continuation of the rally to avoid whipsaw losses.  If they accelerated or magnified the rally, they might accelerate or magnify a retracement, if the market has gone too far too fast, as some suggest.

Richard Shaw
QVM Group LLC

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