When the S&P 500’s returns are at their most negative, dispersion tends to be well above average. When returns are positive, dispersion tends to be slightly below average. This means, other things equal, that a strategy that tends to win when the market is down and to lose when the market is up will have a natural performance advantage, since its hits will occur in times of high dispersion.
This is exactly the pattern of returns exhibited by low volatility indices, as well as by other defensive strategies such as the S&P 500 Dividend Aristocrats. We expect such strategies to do relatively well when the market declines. The remarkable thing about them is that they also tend to outperform over the long run, despite the market’s secular upward bias. Arguably, this is because they tend to win when dispersion is relatively high, and to lose when dispersion is relatively low. They are therefore more likely to outperform when the reward for outperformance is high.
Differential returns can often be a consequence of index dispersion. The distribution of dispersion favors strategies that outperform in down markets.
This article was written by Craig Lazzara, global head of index investment strategy, S&P Dow Jones Indices.
© S&P Dow Jones Indices LLC 2013. Indexology® is a trademark of S&P Dow Jones Indices LLC (SPDJI). S&P® is a trademark of Standard & Poor’s Financial Services LLC and Dow Jones® is a trademark of Dow Jones Trademark Holdings LLC, and those marks have been licensed to SPDJI. This material is reproduced with the prior written consent of SPDJI. For more information on SPDJI, visit http://www.spdji.com