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A good stock picker's market doesn't mean good stock-picking returns
MARKETWATCH 9:53 AM ET 8/11/2017
Falling correlations doesn't mean much better active manager performance

Volatility is back in the market and the so-called "rising tide" environment, where stocks move in tandem to an unusual degree, seems to be ebbing. It's a good time to be a stock picker, right? Not so fast.

While it's true that stock-market correlations have been dropping lately (http://www.marketwatch.com/story/this-chart- offers-hope-for-long-suffering-stock-pickers-2017-02-10), that doesn't necessarily mean that investors are better off trusting their money to active managers, who seek to outperform the market by picking winners, rather than simply following the market passively, as investors have increasingly been doing for years through index funds (http:// www.marketwatch.com/story/passive-investing-a-winner-in-2016-shows-no-sign-of-stopping-2016-12-27).

"Greater diversity of opportunity is a good starting point for active managers who seek to beat index-tracking portfolios, but the active managers still need to pick the securities moving in the correct direction," said Brian Jacobsen, senior investment strategist at Wells Fargo Asset Management. "While it's true that lower correlation among stocks should make fertile ground for active portfolio managers, it can also create a minefield if the managers aren't picking the right stocks."

Whether active managers can actually pick winners, particularly over long periods, has been repeatedly called into dispute. Earlier this week, data from S&P Dow Jones Indices revealed that nearly every type of active stock-based manager underperformed their respective benchmarks over a 10-year time horizon. Among the categories with the fewest number of alpha-generating managers was small-caps, a part of the market that has typically been considered more friendly to active managers (http://www.marketwatch.com/story/heres-where-active-management-can-add-value-to-your- portfolio-2017-04-11).

More detail:Active managers just lost one of their best arguments (http://www.marketwatch.com/story/active-managers- just-lost-one-of-their-best-arguments-2017-08-08)

Active managers have been doing particularly poorly over the past decade given the high levels of correlation, which means stocks rise and fall on macroeconomic issues, rather than on their own fundamentals and trends, an environment it is harder to outperform in.

Now, Jacobsen said, equities "have started to march to the beat of their own drummers," estimating that the 20-day trailing correlation of daily returns for U.S. equities is below 0.2, compared with 0.41 in June 2016. A reading of 1.0 represents perfect correlation, while 0 would mean no correlation at all.

As correlations have dropped, there has been signs that the short-term performance by active managers has gotten better. According to July data from J.P. Morgan, 53% of equity managers are outperforming thus far this year, compared with just 32% over the same period of 2016. There is also data indicating that broader active outperformance is cyclical (http://www.marketwatch.com/story/how-should-active-management-fit-into-ones-portfolio-2017-03-25), and could be poised for a rebound.

Read an interview with investing icon Burton Malkiel, one of the first advocate of passive investing (http:// www.marketwatch.com/story/active-managers-just-lost-one-of-their-best-arguments-2017-08-08)

Jacobsen disputed that point, however, saying that lower correlations only "weakly" correlate with better performance by active mangers.

And of course, investors need to be in the right actively managed fund to take advantage of any outperformance. However, identifying the right fund ahead of time is so difficult that Jeffrey Ptak, global director of manager research for Morningstar, recently wrote it "belongs in what Warren Buffett has called the 'too hard' pile (http:// www.marketwatch.com/story/its-too-hard-to-find-a-good-active-fund-manager-so-dont-bother-trying-morningstar-says-2017- 05-09)."

The solution for investors, then, isn't choosing between active and passive funds, but instead opting for a diverse portfolio, Jacobsen said.

"Lower correlations among stocks mean investors may benefit from a more broadly diversified equity portfolio, rather than benefiting only from getting the sector or theme du jour correct," he wrote to clients.

-Ryan Vlastelica; 415-439-6400; [e-mail]


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