The growing dispersion and correlation levels amid the rapid spreading of coronavirus could be the perfect time for active managers to outperform their passive counterparts, according to a recent report from S&P Global.
With growing concerns regarding coronavirus and the falling price of oil, equity markets have seen billions of dollars wiped out in days. On 16 March, the S&P 500, the largest 500 stocks listed in the US, fell 12%, its worst daily decline for nearly 33 years.
While leading indices are falling double-digit percentage points, some commentators are arguing that this is the perfect market environment for active management to gain an advantage over index funds.
S&P Global agrees with the argument as active portfolio managers have the most potential to add value since relative returns are easier to achieve when absolute returns are poor.
The decline in equity market performances has seen a rise in volatility which manifests itself as both higher dispersion and correlation rates. Dispersion is a measure of the magnitude while correlation is a measure of timing.
The value of stock-selection skills rises when dispersion is high, argues S&P Global, which causes a larger gap between the winners and losers. This then becomes more in favour with active managers who can utilise their stock-picking abilities of specific sectors, geographies and asset classes.
From 1 February until 4 March, rolling 21-day S&P 500 dispersion levels were hovering around 25%. From 4 March until 17 March, these levels climbed consistently to over 45%.
Active portfolios are typically more volatile than their index benchmarks, therefore, active managers forgo a diversification benefit. When correlations are high, the benefits of diversification falls, justifying the use of active management.
Throughout most of February, the rolling 21-day S&P 500 correlations level sat around 0.25. After 22 February, this level climbed to 0.75 by 17 March.
S&P Global concludes by saying the high levels of correlation and dispersion is working in active managers’ favour. However, the high potential for active value added does not necessarily mean actual added value but the firm would not be surprised if the SPIVA results that will come out next year will show an improvement in active managers’ performances.