Is Stock Picking Dead?

Hedge funds are bleeding assets.

Institutional investors are whipped into a frenzy pulling money out, and my inside sources on Wall Street tell me that it’s bad… really bad.

Think about it…

When a manager goes from making $10 million a year to around $1 million, it’s quite a painful sting. I’m not crying for them or anything, but it just goes to show you how intense things can get in the money management world.

What’s the source for all of this pain? Simply put, hedge funds aren’t beating the S&P 500 index.

When the chief investment officers for retirement funds around the country sit before their boards, they have to show results. These folks are allocating billions of dollars to different managers with basically one goal in mind: beat the index.

If the hedge fund didn’t beat the index (which the majority of them weren’t able to do), the investment office has a hard time justifying paying high fees of 2% assets PLUS a 20% take of the profits — for sub-par performance.

Giving Up on Stock Picking

Investors are taking their money from active managers — those who try to beat the index by stock picking — and turning it over to passive managers — funds and ETFs that match the index.

Over the last three years, investors added nearly $1.3 trillion to passive mutual funds!

The reason they are investing in passive funds is simple: superior performance, simplicity, and lower fees.

Already the media is fanning the flames. In the past few weeks, the Wall Street Journal ran a story on the death of stock picking. A few weeks later, it ran a piece on the head of Nevada’s $35 billion retirement fund who put all the assets in low-cost funds that mimic the index and spent a lot of his time doing nothing to manage the assets.

So, what should you do… go with active or passive investing?

My short answer to you is: NEITHER!

And here’s why…

If you’re an intelligent investor and know how to pick stocks, then putting your money in an index fund doesn’t make a whole lot of sense.

Sure, it’s hard to beat the index, but keep in mind that by doing it yourself, you’re not paying management fees or giving up a share of the profits.

Those are two very big hurdles to overcome when you turn over management to an outsider.

The Secret to Stock Picking: Due Diligence

If you do your own research and have the proper temperament to invest, then beating the stock market over the long term is not going to be too big a challenge.

Investing in passive funds such as index funds is the way to go if you don’t have time or expertise to invest on your own. Over time, you will match the index (since you are investing in the index) and have very little to worry about.

However, keep in mind that no matter what valuations the stock market is trading at, index funds will continue to invest your money in the index.

If you don’t think that’s a problem, think back to the dot-com bubble of 2000.

If you invested in the NASDAQ index in 1999, you were looking like a genius — at the end of the year, you were sitting on an 85% return!

It doesn’t get better than that.

As the money poured into the NASDAQ index funds, they kept buying the stocks that made up the index — regardless of the insane valuations.

What was the downside of investing in an index fund? The next three years. During that time, the NASADQ fell -39%, -21%, and -31%.

If you started investing in the NASDAQ index fund starting in 2000, you lost more than two-thirds of your money!

It took the NASDAQ more than 15 years to recover to the high made in March 2000.

Your Next Step

If you have the proper temperament, don’t have a need to trade every day, and are able to put in the time to do your own research… then there’s no reason you shouldn’t be able to the beat the index over a long time frame.

Mr. Market is occasionally mispricing stocks and selling dollar bills for 50 cents. It is those times that you need to buy and reap the rewards.

As more investors plunge into index funds, buying stocks regardless of valuation, that will leave a tremendous opportunity for investors like us who know how to value companies.

Now is the best time to invest, as the market becomes less crowded and opportunities are there for the taking.

All my best,

Charles Mizrahi

Twitter: @IWPeditor

Charles cut his chops on the trading floor of the New York Futures Exchange before moving on to become a wildly successful money manager on Wall Street.

And with more than 35 years of recommending stocks under his belt, Charles has knocked the cover off the ball, compiling an amazing record of success and posting gain after gain for his loyal readers. He is the editor of Park Avenue Investment Club and the Insider Alert newsletters.

Charles is also the author of the highly acclaimed book, Getting Started in Value Investing.