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Challenging the stock-picking consensus
by Robert St George on Mar 03, 2014 at 09:55
It should be inevitable. Less money is flowing from central banks into markets and so buoying all stocks.
A strong and prolonged rally has left many shares on elevated price-to-earnings ratios. And those earnings have begun to disappoint, from US retailers through to British industrials and Japanese conglomerates.
This confluence of factors ought to create a stock-picker’s paradise, with plenty of value to be added by avoiding overpriced companies and diverging from the index.
‘Amid a liquidity-fuelled rally and passive equity fund flows, the valuation gap between a company’s fundamentals and its stock price remains wide. As a consequence, the number of opportunities available to fundamentally driven investors is higher than in the past,’ says Will Jump, chief investment officer for the Americas at AXA Rosenberg.
Concerns about relying on beta have similarly prompted David Coombs, head of multi-asset investments at Rathbones, to take his passive allocation – which has been as high as 25% – to zero.
Investment firm IBoss, which has £500 million of assets under management, has closed its passive range and now only holds one non-active fund – the BlackRock Global Property Securities Equity Tracker – on its buy list.
Set against this presumption in favour of active, though, is some countervailing research from S&P Dow Jones Indices. This focuses on stock market dispersion.
This metric measures the average difference between the return of an index and the return of each of that index’s components. In a high dispersion environment, there is a relatively wide gap between the best and worst performers in the index; when dispersion is low, the stocks all move in a fairly narrow band.
In the latter situation, when shares move largely in concert, the opportunity for an active manager to construct an index-beating portfolio is quite low. Investors would, in theory, be better off in a tracker.
So how dispersed are returns at the moment? Not very. December brought the lowest dispersions on S&P’s records for each of its Developed ex US, S&P MidCap 400 and Europe 350 indices, and the second lowest on record for the S&P 500.
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