573 mutual funds with $3 trillion in assets are most bullish on these 10 stocks in a 'deteriorating stock-picking environment,' Goldman Sachs says — and are underweight some of the biggest tech stocks on the market

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Stocks have steadily sailed to record high after record high in 2021 on the back of blowout earnings growth and easy monetary policy from the Federal Reserve. But Goldman Sachs recently urged investors to take caution in what it called a "deteriorating stock-picking environment."

Mutual funds have delivered strong year-to-date returns, as a Goldman Sachs analysis of 573 equity mutual funds with a combined total of $3 trillion in assets under management found that 43% of large-cap funds have bested their benchmarks in 2021, which is well above the long-term average of 33%.

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Clik here to view. Mutual funds beat benchmarks

But picking winning stocks and avoiding losers is getting increasingly difficult, wrote Goldman Sachs Associate Cormac Conners in an August 23 note. About 57% of funds outperformed in Q1, but only 37% did the same in Q2, and so far just 33% of funds have topped benchmarks in Q3.

"High conviction mutual fund stock positions have lagged since the end of Q1 while return dispersion has also declined, suggesting the fertile stock-picking environment of earlier in the year has deteriorated," Conners wrote.

Mutual funds had the Midas touch early in the year and made prescient overweight bets that economically sensitive small-caps and value stocks would flourish. Nearly 90% of small-cap fund managers have topped the Russell 2000 this year, according to Goldman Sachs.

Investors took note and rewarded fund managers handsomely. Global equity funds have seen $664 billion of inflows this year — more than the cumulative inflows from 1996 through 2020, according to Goldman Sachs. Global equity mutual funds accounted for $133 billion of that total.

Tougher times for mutual funds have come as the rally slowed for small caps and value stocks. Out of the seven long/short factors that Goldman Sachs follows, those are the only two factors with negative returns since Q1, the note read.

"Managers cut exposure to these factors in favor of adding low volatility, high return on capital and strong balance sheet equities in Q2," Conners wrote.

In Q2, fund managers added exposure to quality stocks, including the tech giants that constitute the FAAMG group: Facebook (FB), Apple (AAPL), Amazon (AMZN), Microsoft (MSFT), and Alphabet (GOOGL).

The move was the largest increase in relative exposure to FAAMG stocks since 2017, Conners wrote, but context is vital: All five FAAMG stocks remain among the most underweight positions held by mutual funds.

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Clik here to view. Mutual funds are underweight FAAMG

Large-cap funds' overweight allocations to cyclical sectors like Energy and Financials have boosted year-to-date returns, Conners wrote, adding that the firms also have outsized bets on the "modestly underperforming"Industrials and Materials sectors. One missed opportunity for mutual funds has been their underweight position in the outperforming Real Estate sector.

Cash has been trash, in the eyes of mutual fund managers, who are allocating a record-low level of 1.6% of their portfolios to cash. It's been a good call so far this year and has boosted performance as stocks steadily rise.

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Clik here to view. Mutual funds ditch cash

Below are the 10 stocks that mutual funds are most overweight, according to Goldman Sachs, along with each name's ticker, market capitalization, and price-to-earnings ratio.

Goldman Sachs's basket of 50 stocks in the Russell 1000 that mutual funds are most overweight in is up 20% this year, topping its underweight position counterpart by 4%.