Final answer:
Increasing the percentage of common stocks in portfolios signifies positive market sentiment among institutional portfolio managers. Managers are seeking the higher returns of equities, despite the historical risks associated with stock investments. Performance trends show that picking winning stocks is difficult, and many funds underperform compared to market averages.
Step-by-step explanation:
When institutional portfolio managers are increasing the percentage of their funds allocated to common stock positions, it suggests a positive market sentiment. This shift indicates that managers are expecting potential growth or favorable conditions in the stock market, leading them to increase their equity exposure. The choice to increase stock holdings can also reflect a strategy to achieve higher returns, which are generally associated with stocks, compared to other investment vehicles like bonds or cash equivalents.
Mutual funds serve as a good example of this approach, varying from specialized funds focusing on certain industries or regions to broad-market index funds designed to mimic the market's overall performance. However, it is important to understand that investing in stocks involves risks, as evidenced by historical volatility. For instance, in 2008, the average U.S. stock fund declined by 38%, which could significantly impact investors, especially those nearing retirement.
Historically, it has been challenging for financial investors, including mutual funds that try to pick winning stocks, to consistently outperform the market. A substantial proportion of mutual funds aiming for above-average market performance tend to underperform when compared to broad market indices over time. Therefore, investing in index funds or maintaining a diversified portfolio can help mitigate risks while still participating in the potential growth of the stock market.