The S&P 500 and Dow Jones are trading at a record high as stocks continue to rise

Bloomberg's Lu Wang came out with a great story this morning chronicling the challenges facing active managers in an environment where a few giant companies are pushing the index to record levels.

The basic problem is basic mathematics – the “Big 7” stocks represent about 30% of the S&P 500's weight, investors are prohibited from holding these stocks at that percentage, and the benchmark index cannot keep up by matching the benchmark index. Now, of course, mutual fund managers can line their money with ETFs that track the S&P 500. But that's not why investors are paying the increased fees charged by active funds.

In the case, specifically, it is Investment Company Act of 1940which governs the extent of activity of managed equity funds.

As Morningstar's Robbie Greengold wrote last year, the law “implies that allocating 5% or more to a single security is uncomfortably large; to obtain diversified status, a mutual fund must limit the aggregate stake of these positions.” To 25% of its total shares. Origins.”

The law specifically states in Article 5 that:

Essentially, your fund should be mostly liquid, have investments spread widely, and remain mostly passive as it relates to the management of investee companies. This last part presents another notable problem for the active fund management community.

Most investors who use mutual funds to allocate capital are probably not looking to become active investors. But if so, these rules prevent this potential strategic problem. It's just another way that the investment world is a treacherous place for stock pickers.