Poor fund manager performance could fuel U.S. small-cap portfolio turnover

[October 19, 2016]  By David Randall

NEW YORK (Reuters) - The worst overall performance by U.S. small-cap fund managers in seven years is expected to spur a furious round of portfolio turnover in the last two months of the year intended to capture gains from top performing stocks.

Only 30 percent of actively managed small-cap funds are beating the 7 percent gain in the benchmark Russell 2000 year-to-date, the worst performance by fund managers since 2009, according to Morningstar data.

"Poor relative performance remains a big issue for institutional investors, setting up the likelihood of a performance chase. So we are still buyers of the dip," said Thomas Lee, an analyst at Fundstrat Global Advisors.

The issue of underperformance is especially important this year given looming fiduciary standard rules that will make it harder for pension plans to justify holding expensive underperforming funds, said Todd Rosenbluth, director of fund research at CRFA Research in New York.

Small-cap funds, on average, charge a management fee of approximately 1 percent of assets, according to Lipper, while popular index-based funds such as the Vanguard Small-Cap Index fund charge 0.2 percent of assets or less.

"If you are going to pay up for active management, that manager should have come close or beaten an index-based product," Rosenbluth said.

Much of the poor performance among active small-cap managers this year comes from a tendency among funds to overweight high-growth biotech and technology stocks and underweight slower growing real estate companies, Rosenbluth said.

The Nasdaq Biotech index has dropped 20 percent since January, while the Dow Jones Equity All REIT index is up 6.2 percent.

At the same time, fund managers have crowded into stocks that have stalled, according to Credit Suisse.

Three of the most widely held stocks among small-cap asset managers - network technology company Integrated Device Technology Inc, and biotech company Cambrex Corp, and Ligand Pharmaceuticals Inc - are down 12 percent or more for the year to date, according to Lori Calvasina, Credit Suisse's chief US equity strategist.

Auto-parts supplier Tenneco Inc, meanwhile, is among the most underweight stocks held by fund managers. Shares have rallied 14.7 percent for the year to date thanks to accelerating sales of vehicles such as the Ford F150 truck and General Motors' Escalade that use Tenneco's clean air technology.

"In moderately-growing equity markets fees matter much more," Rosenbluth said.

(Reporting by David Randall; Editing by Daniel Bases and Steve Orlofsky)

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