A combination of extraordinary policy action and substantial passive investment flows had a distorting impact on the U.S. equity market from 2011 to 2021. Because of low volatility and an increasingly concentrated market, active U.S. equity managers struggled to keep up with their passive counterparts during this period. The market dynamics that have been on display for the better part of the past decade are changing in a way that could benefit active management.
A white paper issued by T. Rowe Price argues that when U.S. equity markets display extreme characteristics (concentration, volatility, dispersion of returns), opportunities for active stock picking become more pronounced, and active managers generally outperform index returns as these extremes start to unwind.
“The market dynamics that have prevailed for much of the last decade, such as the exceptionally loose monetary and fiscal policies, are changing,” wrote Josh Nelson, head of U.S. equity for T. Rowe Price. “This transitioning backdrop has traditionally worked to the advantage of quality active managers.”
One headwind facing active managers was that the powerful gains recorded on major U.S. benchmarks were disproportionately driven by a small number of large, growth‑oriented stocks. In 2020, for example, five stocks on the S&P 500 — Alphabet, Amazon, Apple, Facebook, and Microsoft — returned 55.8% for the year, while the remaining 495 stocks in the index returned 10.8%.
Another extreme characteristic of the U.S. equity market over the past decade was the historically low dispersion of stock returns, making it increasingly difficult for active managers to generate differentiated performance.
These factors made it challenging for active managers to generate alpha. Now, the U.S. market environment appears more favorable for active strategies. The impacts of slowing economic growth, high inflation, and rising interest rates are all being reflected in equity markets, with some of the characteristics evident in recent years beginning to unwind.
Market volatility has increased from the historic low levels of recent years, creating more differentiated performance between sectors and stocks. Meanwhile, 10‑year U.S. Treasury yields are sharply higher than their 2020 lows. And with increased volatility being a feature of the U.S. equity market over recent quarters also comes an increase in return dispersions, which should provide active managers with greater opportunities for differentiated performance.
“A number of extreme market characteristics that have proved ongoing headwinds for active managers in recent years — high market concentration, low volatility, low return dispersion — appear to be rolling over,” Nelson added. “Coming from these extreme starting points, we anticipate more pronounced opportunities for quality active managers to generate alpha moving forward.”
As part of its lineup of active exchange traded funds, T. Rowe Price offers a suite of actively managed equity ETFs, including the T. Rowe Price Blue Chip Growth ETF (TCHP), the T. Rowe Price Dividend Growth ETF (TDVG), the T. Rowe Price Equity Income ETF (TEQI), the T. Rowe Price Growth Stock ETF (TGRW), and the T. Rowe Price U.S. Equity Research ETF (TSPA).
T. Rowe Price has been in the investing business for over 80 years through conducting field research firsthand with companies, utilizing risk management, and employing a bevy of experienced portfolio managers carrying an average of 22 years of experience.
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