How Have Stockpickers Done in Volatile Markets?

Given the recent volatility in the markets, it's timely to look at how active managers (those that try to beat the market through stock selection or market timing) have done during times of heightened market ups and downs. We're please to share Dimensional Fund Advisors' perspective.

Active Management Hasn’t Shined in Volatile Markets

By Wes Crill, PhD, Dimensional Fund Advisors Head of Investment Strategists and Vice President

Many investors have likely heard the adage that active management performs better in times of market turbulence. This may sound like an emotional hedge for market stress akin to betting against your favorite sports team to balance an adverse outcome with financial compensation. However, a historical analysis of active US-domiciled equity funds finds no meaningful relation between market volatility and managers’ success rates; the implication is that traditional active investments may compound your concerns during times of market uncertainty.

The rolling three-year standard deviation for US stock market returns, illustrated by the orange line in Exhibit 1, shows recent volatility has been at its highest since the 2008 financial crisis. Whether this portends success by active managers is doubtful. The rolling three-year outperformance rates by active US equity funds (blue bars) imply very little relation with volatility levels. The year-to-year variation in success rates does not consistently track market volatility. For example, rolling averages of daily volatility from 2014 to 2019 were consistent in level and yet the percent of funds outperforming during these rolling periods was not, ranging from 23% to 37%.

Volatile market environments give us enough to worry about – investors can do without unpredictable outcomes from traditional active management.

Exhibit 1

Rolling three-year outperformance rates for active US equity funds vs stock market volatility, January 2005 - December 2021

Past performance is no guarantee of future results.

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Notes

Market volatility computed each month using standard deviation of Fama/French Total US Market Research Index daily returns. Monthly volatility observations are then averaged over rolling three-year periods formed at the end of each year. Outperformance rates are computed over the same rolling three-year periods and are calculated as the percentage of active US-domiciled equity funds that survive the period and outperform their respective Morningstar category index net of all fees and expenses. Sample of active managers consists of funds categorized as active US equity by Morningstar. Fund returns are average returns computed each month, with individual fund observations weighted in proportion to their assets under management (AUM). Index benchmarks are those assigned by Morningstar based on the fund’s Morningstar category.

GLOSSARY

Active management: A portfolio management approach that aims to outperform a market rate or return, or a specific benchmark, by choosing investments that deviate from the market portfolio or benchmark. Standard deviation: A measure of the variation or dispersion of a set of data points. Standard deviations are often used to quantify the historical return volatility of a security or portfolio. 

DISCLOSURES

Fama/French Total US Market Research Index: The value-weighted US market index is constructed every month, using all issues listed on the NYSE, AMEX, or Nasdaq with available outstanding shares and valid prices for that month and the month before. Exclusions: American depositary receipts. Sources: CRSP for value-weighted US market return. Rebalancing: Monthly. Dividends: Reinvested in the paying company until the portfolio is rebalanced. The Fama/French Indices represent academic concepts that may be used in portfolio construction and are not available for direct investment or for use as a benchmark.  Index returns are not representative of actual portfolios and do not reflect costs and fees associated with an actual investment. See “Index Description” above for a description of the Fama/French index data. Results shown during periods prior to each index’s index inception date do not represent actual returns of the respective index. Other periods selected may have different results, including losses. Back tested index performance is hypothetical and is provided for informational purposes only to indicate historical performance had the index been calculated over the relevant time periods. Back tested performance results assume the reinvestment of dividends and capital gains. Profitability is measured as operating income before depreciation and amortization minus interest expense scaled by book. Eugene Fama and Ken French are members of the Board of Directors of the general partner of, and provide consulting services to, Dimensional Fund Advisors LP. The information in this material is intended for the recipient’s background information and use only. It is provided in good faith and without any warranty or representation as to accuracy or completeness. Information and opinions presented in this material have been obtained or derived from sources believed by Dimensional to be reliable, and Dimensional has reasonable grounds to believe that all factual information herein is true as at the date of this material. It does not constitute investment advice, a recommendation, or an offer of any services or products for sale and is not intended to provide a sufficient basis on which to make an investment decision. Before acting on any information in this document, you should consider whether it is suitable for your particular circumstances and, if appropriate, seek professional advice. It is the responsibility of any persons wishing to make a purchase to inform themselves of and observe all applicable laws and regulations. Unauthorized reproduction or transmission of this material is strictly prohibited. Dimensional accepts no responsibility for loss arising from the use of the information contained herein. This material is not directed at any person in any jurisdiction where the availability of this material is prohibited or would subject Dimensional or its products or services to any registration, licensing, or other such legal requirements within the jurisdiction. “Dimensional” refers to the Dimensional separate but affiliated entities generally, rather than to one particular entity. These entities are Dimensional Fund Advisors LP, Dimensional Fund Advisors Ltd., Dimensional Ireland Limited, DFA Australia Limited, Dimensional Fund Advisors Canada ULC, Dimensional Fund Advisors Pte. Ltd, Dimensional Japan Ltd. and Dimensional Hong Kong Limited. Dimensional Hong Kong Limited is licensed by the Securities and Futures Commission to conduct Type 1 (dealing in securities) regulated activities only and does not provide asset management services. Risks Investments involve risks. The investment return and principal value of an investment may fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original value. Past performance is not a guarantee of future results. There is no guarantee strategies will be successful.

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