Youve heard it before. Traditional stock-picking is dead. Long live the machines who rely on complex algorithms to decide what to buy. Bank of America Merrill Lynch is here to throw water on this simplistic assertion. While the firm concedes that so-called passive managers — who largely ignore fundamental analysis — will continue to grow in size, it also sees ample opportunity ahead for active investors.
BAMLs take boils down to one main piece of data: Stocks are more differentiated now than they have been since the financial crisis. Those idiosyncrasies, in turn, create price dislocations that can be readily exploited by traders. Read more: The disruptors will be disrupted: The man who runs the $100 billion SoftBank Vision Fund offers bold predictions for how different the world will look in 10 years This is shown in the chart below, which also finds that sectors have actually been more differentiated than stocks throughout much of the 10-year bull market— until now.
Bank of America Merrill Lynch But ripe conditions arent enough for a stock picker to crush the market. They still need to make correct investing decisions. Thats where the equity strategy team at BAML comes in.
Savita Subramanian, who runs US equity and quantitative strategy at the firm, has put together a handy seven-part list of steps investors can take to give themselves the best chance to outperform.
They are as follows. (1) Pick your battles Industry groups with high performance dispersion (spreads) and low intra-stock correlations may offer the most opportunity for stock-picking, BAML said in a recent client note. The firm notes that the sectors that fit this bill are tech, healthcare, and both consumer staples and discretionary.
(2) Add some ESG Overlaying ESG scores to a quantitative framework can also help add alpha and lead to better risk-adjusted returns, BAML said. BAML has been stressing for months that ESG is an increasingly important signal for investors.
In a September 2018 report, Subramanian predicted that flows into ESG funds over the next few decades could be roughly equivalent to the size of the S&P 500 today. (3) Focus on stocks that act like stocks This suggestion comes back to the central idea that certain stocks have been increasingly trading on factors outside their core fundamentals.
. By simply limiting the universe of stocks to companies with above average idiosyncratic, or company-specific risk, we found that these attributes were rewarded by a much wider margin, BAML said. This dynamic is shown in the chart below: .....