The truth about falling correlations and active stock pickers

 Edward J. Perkin, Chief Equity Investment Officer

Boston - You may have seen headlines trumpeting that a recent decline in market correlations could trigger a resurgence of active stock picking. Although the market moving in a less herd-like fashion is a welcome change and means more opportunity for active managers, one still has to pick the right stocks.

Correlation measures the tendency of stocks or sectors to move together. Since Election Day, the correlations of individual U.S. stocks have fallen dramatically. In other words, stocks are moving largely on their own individual merits. This may be good news for investors who focus on bottom-up, individual security selection.

Potential pro-growth policies out of Washington combined with the Federal Reserve moving away from its zero interest rate policy (ZIRP) appears to be the reason that correlations have recently fallen.

The other important trend for active investors is the increase in the dispersion of returns. The gap between the best and worst performing stocks has widened in recent months. We can think of this as the size of the reward for being right.

The combination of falling correlations and rising dispersion should mean that there is fertile ground for active stock pickers and they will be well rewarded when they get the individual stock calls right.

Bottom line: Active equity managers have had a tough time of it in recent years, but I believe we are at a cyclical low for active performance.