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Challenging the stock-picking consensus

by Robert St George on Mar 03, 2014 at 09:55

In the year to the end of January, the S&P 500’s average dispersion was 5% compared with its five-year average of 7.1%.

For the Europe 350 it was 5.2% against the long-term average of 7.1%, and for the S&P Emerging BMI index it was 7.9% versus 8.2%.

‘In a low dispersion environment, the argument in favour of passive funds is very strong,’ said Tim Edwards, director of index investment strategy at S&P Dow Jones Indices.

Before piling into passive, however, it is worth reflecting on the experience of the past year. It should have been the most difficult ever for US stock-pickers.

Through 2013, the average 5% dispersion between returns from S&P 500 stocks – commonly cited as the world’s most efficient market – was the lowest reading in the 23-year data-set compiled by S&P. The highest recorded dispersion was 13% in 2000; in 2012 it was 5.5%.

‘Rarely in history did the average stock deviate so little from its peers or from the market,’ Edwards says.

‘In such circumstances, the relative value of active management in the equity markets is constrained. Simply put, accurate bets deliver less alpha.’

He accepts 2013 delivered ‘plenty of individual equities that recorded stellar or catastrophic performances’, but says on average, such instances were less commonplace and less dramatic last year.

Yet active US managers had one of their best years. According to Citywire data, the average North America equity fund has lagged the S&P 500 over three, five and 10-year periods. But during the 12 months to the end of January, the average fund beat it with a return of 17.6% to the index’s 17.2%.

The S&P research acknowledges this, finding an uncorrelated pattern over the past decade between dispersion and the proportion of outperforming funds.

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