Heightened volatility and higher correlations offer chance for stock-pickers to outperform
As U.S. equities continue to get whipsawed and the S&P 500 registers its worst losses in decades, buy-and-hold passive investors are likely facing the greatest test of their patience yet. In contrast, active managers might outdo their index-tracking rivals — assuming they don’t throw away their shot.
“We are in precisely the environment in which active portfolio managers have the most potential to add value, since relative returns are easier to achieve when absolute returns are poor,” said Anu Ganti, director of Index Investment Strategy at S&P Dow Jones Indices, in a blog post.
Ganti noted that the current volatility in the stock markets has been characterized by high dispersion — that is, pronounced gaps between winners and losers. As rolling 21-day dispersion levels in the S&P 500 have jumped since early March 2020, skillful active managers have a chance to show off their stock-picking prowess.
“Higher dispersion also offers greater opportunities for skillful active managers to add value from selecting among sectors, countries, and asset classes,” Ganti added. In an analysis of S&P 500 sectors, S&P Global BMI Countries, and asset classes, she found that dispersion across all categories have been similarly on the rise since early this month.
And while investors around the world have been punished by high correlations, Ganti argued that it could be a prime opportunity for active managers to outperform index-trackers. Passive strategies often rely on diversification, which becomes less effective when correlations are high. Active managers, meanwhile, tend to forgo diversification and are more prone to maintain high-conviction portfolios.
Ganti shared an analysis showing that as macroeconomic risk has escalated, rolling 21-day S&P 500 correlation levels have increased, reaching an all-time record on March 16.
“Both high dispersion and high correlations are now working in active managers’ favor,” she said. “However, high potential for active value added does not automatically translate into actual value added.”