The Intelligent Allocator: The humbling art of stock picking

For decades, equity investors have debated a deceptively simple question: if professional stock pickers spend their careers analysing companies, why do so few consistently outperform the market? The answer is neither that active management is obsolete nor that skill has disappeared but that investing is a humbling craft in which time, discipline and patience are at least as important as insight.

Retail investors – whose fondness for ‘meme’ stocks, leveraged exchange traded funds and other speculative instruments has drawn attention since Covid – now account for more than 17% of US equity volume, according to Bloomberg data. That is more than traditional equity fund managers (6.6%) and hedge funds (9.4%) combined. In theory, that should make it easy for these few professionals to outperform the average. Yet the majority of actively managed funds have struggled to deliver.

Concentration is a false alibi

The stock picker's difficulties are often blamed on concentration because ‘a handful of stocks drives the index’. This is true, but hardly new, and a poor alibi in isolation. Since 2020, setting aside the market declines of 2022, the top five stocks have delivered on average 43%, and the top ten names delivered 56% of the MSCI USA's annual returns. In the first half of 2026, the equivalent figures are 45% and 65%.

A recent study calculates that across thousands of US companies between 1926 and 2025, the median stock lost money over its listed life. Over the decade since 2016, the median stock returned just 1.4%, despite the highest index gains in a generation.

Across thousands of US companies between 1926 and 2025, the median stock lost money over its listed life

This is because while a stock can lose at most 100%, its upside is unlimited. A tiny minority of names can gain thousands of percent, lifting the average far above what a typical stock delivers. According to the same study of nearly 30,000 US stocks, just 1,082 firms account for all the USD 91 trillion in net shareholder wealth created over the century, and just 46 companies account for half of that. Most stocks, most of the time, fail even to keep pace with the buy-and-hold return on one-month Treasury bills.

The stock picker’s task is therefore less about avoiding losers than finding the handful of names in a generation that do all the work and holding onto them at scale for decades, without losing one's nerve. That is why the art is humbling.

The stock picker’s task is about finding the handful of names in a generation that do all the work and holding onto them at scale for decades, without losing one's nerve

The odds against the stock picker

The tempting explanation for the underperformance of active managers is that they are not good enough. Yet a 2014 study by two US academics found that manager skill is real, measurable, and surprisingly persistent. The difficulty is that success attracts assets. Much of a stock picker’s edge is in smaller companies and these positions cannot grow with a fund because no-one can hold a billion-dollar stake in a half-billion dollar firm. As assets grow, the best investments tend to shrink as a share of the fund. By the time a skilful manager is famous, much of their advantage has been diluted. Uncrowded skill is therefore the scarce investment resource.

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For the fund investor, the second headwind is cost. The trend is improving: the average expense ratio of actively-managed US equity mutual funds fell from 1.06% in 2000 to 0.64% in 2025, according to recent data. But more relevant is the difference versus passively-managed funds. The average index US equity mutual fund now costs 0.05%. That means the hurdle is roughly 0.6 percentage points, every year, before an actively-managed fund can outperform.

The average expense ratio of actively-managed US equity mutual funds fell from 1.06% in 2000 to 0.64% in 2025

For anyone holding stocks, whether in a fund or as a direct investment, the headwind is different and less discussed: the flow of money towards passive funds. Every dollar that moves from active to passive funds works against the stock picker. First, active funds must sell what they own, above all their favourite and less-owned names. Then the index fund mechanically buys the whole market, including the big names that active managers tend to own least. A recent prize-winning study quantifies this squeeze. Since 2010, the average active fund's annual lag behind its benchmark has widened by about one percentage point, roughly doubling it. The portfolios that differ most from the index, once the best performers, are the most penalised. Being different now means swimming against the stream.

Finally, as information becomes more accessible and the average fund manager’s skills improve, the differences between them narrow, leaving fewer opportunities for outperformance.

Consistency outshines brilliance

Half a century ago, investor Charles Ellis borrowed an observation from tennis: among professionals, the point goes to whoever produces the unreturnable shot, but when amateurs play, matches are decided by mistakes. Ellis's thesis was that once financial markets filled with hard-working professionals, brilliant shots became standard, and the decisive variable became the error.

So what has a ‘brilliant win’ paid? The three best-performing US equity funds of the past 25 years compounded some four percentage points annualised above the index. The same few recurring names in the industry prove the rarity. Even among these, Warren Buffett has trailed the S&P 500 in 20 of the past 60 years. Peter Lynch, over 13 years at Magellan, lagged the index in two of them. Bill Miller's 15 consecutive winning years remain the record.

And the lag is sometimes analysis at work. In 1999, Berkshire Hathaway was trailing a technology-dominated index so badly that financial magazine Barron's asked "What's Wrong, Warren?". The dot-com bubble burst three months later and over the following three years the market lost about 40% while Berkshire rose by a similar amount. Not owning the market's leaders can mean that either a manager failed to see them, or that they saw them priced for the impossible, and said ‘no thanks.’ For investors, only time can differentiate discipline from blindness.

Yet small, persistent edges can also compound over time. Since 1980, on a total-return basis, the Dow Jones index has lagged the S&P 500 by roughly one and a half points per year, or an annualised 10.7% against 12.2%. Compounded over four and a half decades, that modest gap gave the S&P investor nearly twice the wealth. The comparison shows that the choice of the benchmark is itself an active decision.

In an environment where active outperformance is rare, it is no accident that low tracking-error funds have been gathering assets. These funds are designed to deliver returns that stay within range of the benchmark index, while permitting modest deviations that aim to generate positive outperformance.

Active management still earns its keep

We are believers in market efficiency. Prices reflect new information with speed, and recent research shows they still reflect real information. But speed is not the same as judgement. The market is a fast calculator but an unreliable philosopher, pricing news within seconds and occasionally misreading its meaning.

The market is a fast calculator but an unreliable philosopher, pricing news within seconds and occasionally misreading its meaning

These intervals are where active management thrives. They appear when market dispersion widens, or a geopolitical shock or new technological narrative makes stocks move in tandem, mispricing strong businesses with fragile ones. Such moments are infrequent and uncomfortable. Acting on them requires a willingness to look wrong, which is another way of saying it requires time, discipline and conviction.

An investor who needs access to capital over a short period can do much worse than owning the market. An investor who can commit to locking up capital for longer can absorb tracking error in the quieter corners of the equity market. Here, the odds are historically friendlier to stock-picking skills in smaller companies and emerging markets, or through long-term thematic strategies, such as our rethink investments framework.

What matters is the discipline to stick with the chosen approach. While broad market exposure remains a powerful default option, investors with a longer time horizon can give skilled active managers room to add value where and when markets are less efficient. For asset allocators, the advantage lies in combining the two for optimal portfolio outcomes.