Most Stock Mutual Funds Lagging their Benchmarks Thus Far in 2011 - Setting Up a Late Year Rally?

Interesting statistic via InvestmentNews - looks like a mass of underperformance versus benchmarks in the mutual fund world this year.  A bit surprising since the 'long only, cash is trash' ideal worked wonders January thru April and I would assume in that environment, a lot of people did fine -  but I guess the more recent downturn hit individual funds much harder than the indexes. 

Keep in mind with correlations at record highs [Aug 25, 2011: Student Body Left, Student Body Right Trading Returns as Correlations Surpass that of Even 2009, 2010], it becomes very difficult to truly detach too far from the indexes (esp on the equity side) - hence I am surprised a bit more funds are not at least more or less keeping pace with the overall market.

• Stock mutual funds are having their worst year since 1998 relative to their benchmarks, as higher volatility makes it harder to pick stocks, according to JPMorgan Chase & Co. (JPM).  Among 2,806 funds tracked by the brokerage, 47 percent underperformed their benchmarks by more than 2.5 percentage points this year, the most since the 55 percent recorded in 1998. 
• Only 13 percent of the funds beat the market by the same margin. The underperformance accelerated last month, with the proportion of trailing funds almost doubling from July, according to JPMorgan data.
• “The turbulence of markets in August caused a rapid deterioration of active manager performance,” Thomas J. Lee, JPMorgan's chief U.S. equity strategist, wrote in the report dated yesterday.

Mr. Lee likes to track underperformance of funds and generally believes when that happens, managers reach for more risk and therefore we should expect a rally.  (I've seen similar thoughts from him in the past). 

• The trailing funds are likely to increase holdings in companies that move the most relative to the benchmark, known as high-beta stocks, to boost performance, Lee said. That preference may result in a year-end rally, he said.
• “When active managers trail, there is a tendency for markets to rise into” the end of the year, Lee wrote. “Intuitively, when there are more trailing, there will be logically an attempt to outperform, which should be driven by risk-taking.”

Pretty interesting track record - 2008 obviously was an anomaly due to world events, but then again with Europe a mess, 2011 might be considered one as well.

• Since 1995, there had been nine years when more funds trailed than those that beat from Jan. 1 through Aug. 31. The market rallied in the last four months of a year in all but 2008, with the S&P 500 rising 8.5 percent on average, JPMorgan data showed.