The spread between the best and worst managers did widen or narrow with greater dispersion. That is what you’d expect — with a wider band of stock returns, there is more opportunity to do well or perform badly from the active standpoint.
Just to emphasize, today’s dispersion readings are quite low.
Your research note showed that from 2003 to 2012, that in eight of the 10 years, active managers underperformed the S&P 500. What does that say to you about active managers?
Craig Lazzara: I’d start by asking: What is the market’s capacity to generate alpha, and what is the market’s capacity to generate beta? The North American stock market is worth $20 trillion1. The market’s supply of beta is $20 trillion worth. It gets marked up and down with the market every day—but at any point in time, it’s easy to measure. Now, what is the market’s capacity to generate alpha? Zero. The only way I can be above average is if someone else is below average. The weighted average outperformance of the outperforming managers has to equal the weighted average underperformance of the underperforming managers. Given that there is no natural supply of alpha, and active management costs more than passive, it is not surprising that the majority of active managers underperform a passive index.
When looking at dispersion across size segments, what did you find from large caps to small caps?
The mid- and small caps consistently have greater dispersion than large caps. They tend to follow the same general pattern and are currently at the low end of their historical range—as are large caps. One way to interpret that: There is more market opportunity for managers who are picking stocks to outperform or to underperform in the mid- and small-cap stock segments compared to large caps.
Does that dispersion lead to better performance for active managers trying to outperform in mid- and small caps? No. The mid- and small-cap stocks have about the same percentage of active managers underperforming as large caps. But there is a greater differential and range in returns between the best and worst active managers in the mid- and small-cap space.
Craig, thanks for taking the time to speak with us about your research.
For more information S&P Dow Jones Indices’ research on active managers, please see its SPIVA study here and their note on dispersion here.
1As of 01/31/2013.
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