When fund managers whisper, listen up

• Fund managers tend to think stocks are overvalued when returns are strong, sentiment is upbeat, and the outlook is rosy – and historically, they’ve been right more often than not
• Retail investors usually chase trends – they get the most bullish after rallies, which makes their sentiment a better contrarian indicator than a reliable signal
• Right now, stock allocations are near record highs, valuations are stretched, and retail optimism has rebounded. That combo has historically led to lower returns over the next three years, so that makes this a good time to be selective, not aggressive.

Let’s be honest: fund managers get a bad rap. Too slow, too herd-driven, too worried about getting fired to take real risks. I’ll admit I’ve always treated the Bank of America Fund Manager Survey – a monthly pulse check with the folks managing over $600 billion – like a contrarian signal. When they’re too optimistic, I brace for the dip.

But a new academic study says I’ve been looking at it all wrong. When fund managers say the market looks cheap (or pricey), they’re often early. And right.

#1: Fund managers lean contrarian – and they’re usually on the money

The study mostly focused on one question from the Bank of America survey: do institutional investors think stocks are undervalued or overvalued? Researchers called it “perceived underpricing” – and then ran the numbers to see whether it accurately predicted future returns.

Turns out, it did. And it’s not because fund managers are blindly optimistic. Quite the opposite. They tend to call stocks “undervalued” when things look rough – after selloffs, during economic stress, or when company fundamentals are cracking. And they call stocks expensive when everything feels great: when returns are up, risks are low, and the outlook is rosy.

That’s what makes it useful. When perceived undervaluation ticks higher, stock returns over the next three years tend to climb too – by about 2% a year. And that signal holds up even after accounting for the usual suspects like price-to-earnings ratios, dividend yields, or volatility. In short: these pros aren’t just reading the same headlines as everyone else – they’re picking up on the mispricings that matter.

Oh, and it’s not just stocks. The same logic worked across most asset classes they tested – with strong results everywhere except gold and the Japanese yen.

#2: The pros don’t actually act immediately – but that’s your opportunity

Here’s where it gets interesting. Even when fund managers spot value, they don’t immediately pile in. The study found that their portfolios don’t reflect their valuation views right away – not because they’re uncertain, but because they’re constrained. They’ve got client mandates, risk teams, liquidity rules, and the ever-present fear of being wrong and having to talk to the boss about it. And the reverse happens too: when they believe stocks are overvalued, they don’t immediately get out.

In the short term, it’s risk perception that drives decisions, not fundamentals. So even when they see a bargain, they might hold back if recession risks are swirling or liquidity is tight. Eventually, though, their views will seep into their positioning. When fund managers see stocks as undervalued, equity allocations and fund flows will rise – just not immediately. Again, the reverse happens: when they see stocks as overvalued, they only gradually pull back.

And that delay is the opportunity. The signal didn’t say much over a one-year horizon – but over two or three years, it packed a punch. Belief leads behavior, but it doesn’t happen overnight. So spot the sentiment shift early, and you’ve got a head start on the big money.

#3: Retail sentiment is loud – but mostly useless

The study also checked how retail investors stack up, using the AAII survey as a benchmark. The verdict isn’t great. Retail sentiment is classic, chase-the-feeling stuff: up after rallies, down after selloffs. In other words, reactive – not predictive.

And when tested alongside institutional sentiment, only the pros showed any real forecasting power. Retail views didn’t add value – and often pointed in the wrong direction. In fact, the best signals came from divergence: when retail investors were euphoric and fund managers were skeptical, markets tended to disappoint. But when retail panic was peaking and the pros saw opportunity, returns looked a lot better.

So, what’s the opportunity?

The bad news: the exact “undervalued vs. overvalued” question that powered the study’s predictive punch hasn’t featured in the Bank of America survey since 2017. But there are still ways to read between the lines. The survey still tracks stock allocations, cash levels, big-picture expectations, earnings outlooks, and risk appetite. They’re not perfect substitutes – the study was clear about that – but they offer decent clues, nonetheless.

Here’s how we could connect the dots from what we learned. Fund managers tend to perceive undervaluation when recent returns are weak, the macro picture looks grim, retail sentiment is in the gutter, and valuations are low. The opposite – strong returns, upbeat outlooks, high valuations, and bullish retail sentiment – tends to align with perceived overvaluation.

Right now, the setup skews more toward the latter. Returns have been solid (though choppy), the outlook is generally upbeat (especially around earnings growth), valuations are elevated, and retail sentiment is clearly positive – albeit not frothy. None of this screams “undervalued”. In fact, most long-term forecasts from asset managers suggest stocks are expensive and likely to deliver subpar returns. And with stock allocations near record highs, the belief that stocks are undervalued is probably well behind us. If anything, it’s a sign that optimism is priced in – not that bargains are lying around. So that all points to caution. Of course, just because markets look overvalued doesn’t mean a crash is coming – or that fund managers are about to short stocks. But it does raise the odds of subtle shifts in positioning and lower returns over the next few years. And that kind of backdrop suggests being selective, not aggressive.

Stéphane Renevier is an analyst at finimize.

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