Lower intrastock correlations favor alpha strategies

From the Columbia Management Quantitative Strategies Equity Research Group

Chart: Trailing 12-month S&P 500 Index stock correlation and quarterly aggregate alpha

10-year timeline: Four periods of correlations and alpha 2003–2013

A: The pre-crisis period -- Prior to the financial crisis, intrastock correlations were the lowest in the last 10 years, and for most of this time alpha was positive.

B: The financial crisis -- Unsurprisingly, alpha was worst during the 2008–2009 crisis. Surprisingly, given the breadth of the equity rally, alpha was highest in the 2009 rebound that followed.

C: Post-crisis uncertain recovery -- Macroeconomic worry dominated the post-crisis environment, overwhelming the virtues of individual stocks, thwarting stock-pickers.

D: Post-crisis stability -- As intrastock correlations fell to their lowest level post crisis, alpha is once again mostly positive, rewarding active managers.

 

Methodology

Quarterly aggregate alpha: Fund performance, AUM and style classification data is from Morningstar and FactSet. Only funds classified in the Morningstar nine style boxes were included, meaning many specialty funds were excluded. To compute the gross excess returns (alpha), the corresponding Russell benchmarks for the asset classes were used. Both inactive and active funds were included in the calculation. Index funds and enhanced index funds were excluded. Aggregate alpha for the Morningstar funds was calculated using the square root of the AUM-weighted mean, as this lessens the influence of very large funds on the result without completely discounting size.

Trailing 12-month stock correlation: The stock correlation is the average rolling 12-month daily pairwise S&P 500 Index stock correlations. The S&P 500 Index tracks the performance of 500 widely held, large-capitalization U.S. stocks. It is not possible to invest directly in an index.

The illustrations here are not intended to be representative of the performance of any particular investment. Such information analysis has inherent limitations and may not be indicative of future results. It is important to keep in mind that no formula, model or tool can in and of itself be used to determine which securities to buy or sell, or when to buy or sell them.

 

Tagged with: Equities, Investing

About the Contributor

The views expressed in this material are the views of the author through the date of publication and are subject to change without notice at any time based upon market and other factors. All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such. This information may contain certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those discussed. There is no guarantee that investment objectives will be achieved or that any particular investment will be profitable. Past performance does not guarantee future results. This information is not intended to provide investment advice and does not account for individual investor circumstances. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon and risk tolerance. Please see our social media guidelines.

About Us

Backed by more than 100 years of experience, Columbia Management is one of the nation’s largest asset managers. At the heart of our success and, most importantly, that of our investors, are highly talented industry professionals, brought together by a unique way of working. At Columbia Management, reaching our performance goals matters, and how we reach them matters just as much.