Courtesy of Joshua M Brown
Why have stock-picking fund managers had it so tough over the last few years? A lot of people would say high correlation in the stock market, but that’s only part of the story. According to Goldman Sachs strategists, the real culprit is low dispersion. We’ve talked about this topic here before, but to rehash: Dispersion is a measurement of how stocks act in relation to each other, not just to the overall market.
A high-dispersion environment is where a large number of stocks are zigging and zagging drastically. This means that returns and risk factors are all over the map, which, in theory, would allow skilled stock-pickers to greatly differentiate themselves. In a low-dispersion environment, which is what Goldman expects to continue throughout 2015, it’s harder to select stocks that will move meaningfully based on individual company micro-drivers (fundamental changes, news, etc).
The two charts below show how the stock-pickers struggle when dispersion is low and alpha grows scarce:
You’ve also likely noticed that funds have trouble outperforming during bull markets generally, but we’ve been over that too (see: Why Active Management Fell Off a Cliff).
Strategist David Kostin & Co ran an analysis that measured the S&P 500 stocks for dispersion potential and the tendency to move independently.
They find that the stocks with the potential for high dispersion are most likely to fall into either the information technology or consumer discretionary sectors. This makes intuitive sense – consumer disc companies see radical changes in stock price as a result of the capricious preferences of shoppers while in technology, individual-company innovation is the big driver. Energy, materials and staples – with largely commoditized products to sell – tend to see the lowest amount of dispersion among their stocks.
GS emphasizes that picking stocks with high-dispersion tendencies will be the key to outperformance this year, long or short. The best hunting grounds are in the retailers, techs, biotechs and luxury brands.
Picking stocks in a low return dispersion market
Goldman Sachs – March 30th 2015