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Fund Watch

Why 2014 Was a Tough Year for Active Fund Managers

The Kip 25’s stock mutual funds couldn’t keep pace with the S&P 500 index.

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What’s up with our favorite U.S. stock funds? None of the 12 actively managed funds in the Kiplinger 25 beat the broad market over the past 12 months. The reason: Big-company stocks blew away their small-cap brethren.

Tool: Kiplinger's Mutual Fund Finder

Small- and large-capitalization stocks rose in lockstep in late 2013 and early 2014. “Everything was moving in sync,” says Chris Brightman, of Research Affiliates, a Newport Beach, Calif., money management firm. The Russell 2000 small-cap index and Standard & Poor’s 500-stock index, which tilts toward big firms, each rose more than 7% in the five-month period that ended last March.

But then investors started getting nervous and embarked on a flight to quality, marked by gains in the dollar and Treasury bonds, says Brightman. In turn, large-cap stocks rose 9.0% from March 31 through October 31, while small caps, perceived as riskier, were up only 0.8%. “If you were an active manager holding a lot of small-company stocks, you would have underperformed the market,” says Gregg Fisher, of Gerstein Fisher, a New York City money manager. Funds with major stakes in foreign stocks suffered, too. The MSCI EAFE index, which tracks big-cap stocks in developed markets, fell 3.2% over that stretch.

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Thus, the Kip 25 funds with the most exposure to small caps tended to fare poorly; those with the least exposure fared better. To wit: The three small-company funds in the Kip 25—Baron Small Cap (BSCFX), Homestead Small-Company Stock (HSCFX)and T. Rowe Price Small-Cap Value (PRSVX)—trailed the S&P 500 by between 9 and 13 percentage points over the past year. By contrast, two funds in the Kip 25 that are among those with the slimmest exposure to small and mid caps, Dodge & Cox Stock (DODFX)and Vanguard Dividend Growth(VDIGX), fared better over the past 12 months. They have 12% and 2% of their assets, respectively, in small caps and mid caps.

And yet, the funds still lagged the S&P 500. The reason: They didn’t own the right big-cap stocks. The top 100 firms by market value in the S&P 500 returned 19.8% over the past year, 2.9 percentage points more than the index itself. Active managers typically seek—and find—more opportunity in the smaller firms of the S&P 500, says Brightman, and don’t invest as much in the index’s biggest outfits because those tend to be closely followed and fairly priced.