Two out of three large-cap funds lagged the S&P 500 in the first half of the year

There's plenty of evidence that, if you were to pick a mutual fund at random, the odds are high that it will lag the S&P 500.

Picking market-beating stocks has not become any easier this year, according to the latest S&P Dow Jones Indices report on mutual-fund performance.

For the first six months of this year, according to the company's recent report, 67% of large-cap domestic equity funds underperformed the S&P 500 SPX. That's almost precisely the average extent of underperformance in each of the past 25 years.

These findings put to rest the widespread speculation from earlier this year that, because market leadership in the first half of the year was rotating away from the largest-cap stocks represented by the so-called "Magnificent Seven" tech companies, a greater percentage of mutual funds should beat the market. That's because the S&P 500 is a market-cap-weighted index and its performance disproportionately suffers when its largest stocks perform poorly.

This argument had at least superficial plausibility, since for the first half of this year the average Magnificent Seven stock lost 3.1%, according to LSEG data. Yet beating the market was still difficult: The percentage of mutual funds lagging the S&P 500 was virtually no different in the first half of this year than the past 25 years' average.

The new report from S&P Dow Jones Indices also puts to rest the argument that AI would lead to a greater percentage of mutual funds beating the market. That's not the case, despite AI's use becoming widespread on Wall Street. A March survey from Mercer found that "55% of asset managers report AI is integrated in at least one of their strategy's investment processes, 27% are at pilot/proof-of-concept, and only 18% report no integration yet." If AI made it easier to pick market-beating stocks, we therefore should have seen a much lower percentage this year of mutual funds lagging the market. But as you can see from the chart, AI has made no detectable difference.

This year's results provide yet more evidence that, if you were to pick a mutual fund at random, the odds are high that you will lag a broad-market index fund.

But what if the best mutual funds are able to repeat?

The standard comeback to this conclusion is that we don't have to pick a mutual fund at random, but can instead pick those that have the best past performance. If those best performers have above-average odds of continuing their winning ways, do we really care that the majority of funds are losers?

We wouldn't care - if last year's best performer had an above-average chance of beating the market this year. But that is not the case. We know that because of the very high percentage - over 90% - of mutual funds that have lagged the S&P 500 for cumulative performance over the past 20 years. This is represented by the green line in the above chart. That line would be significantly lower if there were greater persistence in mutual funds' ranks in the yearly performance scoreboards.

The bottom line: Yet again, we see that it's incredibly difficult to beat a simple strategy of buying and holding a broad stock-market index fund. If you can't beat the benchmark even when it is handicapped by the lagging performance of the biggest stocks, and even with AI becoming as widely used as it has been, what makes you think the odds will be any better in the future?

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com

-Mark Hulbert