Bad News for Active Management: Correlations High & Dispersion Low

 

sandp-correlation-and-dispersion-dashboard

According to the excellent S&P Indexology Blog, dispersion and correlation – two key measures of the potential for active management to add value – were flashing warning signs for active management at the end of Sept 2016.

Dispersion across most equity market is very low, meanwhile correlations have risen – generally, a bad combination for active returns.

In addition to the Indexology Blog, Michael Mauboussin’s paper Minding the Opportunity is an excellent resource for those wishing to learn more about how dispersion and correlation can be used to measure the potential for active management.

It will be interesting to see what effect the Trump rally has had when the December-end numbers are released.

 

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2 comments

  1. Daniel, do you think that dispersion and correlation could be lagging rather than leading indicators for active management? I.e. Is now a good time for active management and the historical returns we’ve seen are reflected in the dispersion and correlation numbers you’ve shown?

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    • Thanks Chris, excellent question. Here’s what S&P has to say about it:

      The S&P 500 displays a few features of dispersion that are typical of equity indices:
      • Mean reversion within a limited range. For the S&P 500, more than half of all readings fall between 5%
      and 8%. Levels below 4% and above 15% are so rare that the 4-15% range can be regarded as defining
      dispersion’s practical limits for this index.

      • Long periods of relatively high or low dispersion occur. In fact, dispersion can be rather persistent. Its monthly autocorrelation during the time studied is 0.76, which suggests that current levels of dispersion may provide an accurate guide to the immediate future.

      http://www.au.spindices.com/documents/research/research-dispersion-measuring-market-opportunity.pdf

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