Stock pickers are increasingly beating the broad market after a record May performance for managers of large cap US equity funds.

Last month, 70 per cent of active fund managers outperformed the Russell 1000 index, making it “one of the best months in history”, according to Bank of America, and the strongest May in at least three decades. February proved slightly stronger, at 70.3 per cent. Those two months now ranked as the strongest for active managers since June 2007, said Ohsung Kwon, US equity strategist at the bank.

The generation of outperformance, or alpha, suggests that with big tech stocks fading in dominance over US markets, bargain-hunting fund managers could snap two decades of drab returns.

“What you saw in May and indeed all year has been the underperformance of the largest names in the index,” said David Giroux, chief investment officer of equities and multi-assets at T Rowe Price. “Most active managers . . . tend to own more small and mid-caps, so the current market trends have benefited them quite a bit.”

This marks a rebound. In the past 12 months, only around one-third of active managers have beaten the Russell 1000. But so far this year, more than 60 per cent have outperformed.

Compared with the blue-chip S&P 500, a tougher index to beat, the long-run performance has been poor for several years. Just over 60 per cent of actively managed large-cap US equity funds underperformed the S&P 500 in 2020, and 75 per cent failed to beat the benchmark over the past five years, according to S&P Global, the data provider. So far this year, almost half of funds are succeeding in outperforming the index.

The period since November’s pandemic vaccine breakthroughs has boosted a wider range of companies, particularly some of the smaller components of the Russell index.

Last month, 54 per cent of Russell 1000 shares outperformed the benchmark, up from 46 per cent in April. This breadth helps large-cap active funds to own more winners.

Column chart of Russell 1000 is beaten by 70% of active fund managers showing Stock pickers record their best May returns in three decades

A bias towards cheaper “value” shares in active portfolios is helping. “We are still relatively early in this transition [from growth to value] and it can run for the next 12 to 18 months,” said Colin Moore, global chief investment officer at Columbia Threadneedle. “It is no longer just 20 stocks driving the S&P and we now have a broader spectrum of companies to choose from.”

For now, stock pickers can gain comfort that the correlation between stocks in the S&P 500 is below its long-term average, BofA’s Kwon said. The lighter tendency for stocks to move in lockstep generally throws out opportunities. However, Kwon warned that the performance between those stocks beating the market and those that were lagging behind was narrowing. That means that even if an active manager selects all the winners, the ability to significantly outperform a broad index is reduced.

“There is no easy playbook when it is a fast economic cycle, and the job of active manager is to see around corners,” said Tony DeSpirito, chief investment officer of US fundamental active equities at BlackRock. “This is fertile ground for active management.”

After the shift from growth to value, DeSpirito expects quality cyclicals such as dividend-paying industrials to stand out. “Later in the business cycle, quality does shine,” he said.

Line chart of A declining trend challenges stock pickers showing Alpha opportunities in the S&P 500 swing from abundance to scarcity