This Year, Mutual Funds Should Have Bought the Stocks They Hated

(Bloomberg) -- Mutual-fund hotels have roaches.

In a note to clients, Goldman Sachs Group Inc. Chief U.S. Equity Strategist David Kostin chronicles the "challenged" performance of a group of mutual funds that have a cumulative $1.5 trillion in assets under management.

While the S&P 500 is up almost 6 percent in 2016, Goldman's index of the stocks most favored by mutual funds is flat year-to-date. Basket constituents include three of the 'FANG' stocks — Facebook Inc., Amazon.com Inc., and Alphabet Inc. (Google) —  as well as companies  like Visa Inc., JPMorgan Chase & Co., and Salesforce.com Inc.

To throw salt in mutual funds' wounds, a basket of stocks composed of their underweight positions has performed better than the S&P 500 in 2016.

According to Kostin, mutual funds have misjudged equity-market performance at the industry level. 

"At the sector level, the most overweight sectors, such as Financial Services, have lagged the market while out-of-favor sectors have outperformed," he writes.

However, there are signs the funds will get back on track: the strategist notes that the basket of mutual funds' overweight stocks started to marginally outperform both the S&P 500 in the third quarter, which he attributes to sector rotation in favor of cyclicals like information technology.

Still, "low GDP growth and uncertain Fed policy pose risks to Cyclical outperformance through year-end," cautioned Kostin.

Goldman's mutual-fund overweight positions index has substantial overlap with its hedge fund 'very important positions' list, suggesting that both have bet on the wrong horses in 2016.

The poor performance of stocks beloved by mutual funds has translated into underperformance in aggregate, with only 16 percent of large-cap mutual funds posting better returns than their benchmarks year to date, compared to the 10-year average of 37 percent, Kostin concludes.

To contact the author of this story: Luke Kawa in New York at lkawa@bloomberg.net.

To contact the editor responsible for this story: Isobel Finkel at ifinkel1@bloomberg.net.