What Do Falling Correlations Mean for Active U.S. Equity Managers?

March 08, 2017

The Implied Correlation Index measures the average correlation of the stocks in the S&P 500 index. When the index is high, individual stocks are more likely to move in tandem with the broad index; when it is low, return dispersion among stocks in the index will be higher.

Looking at the 1 year chart above, the correlation downtrend is easily visible. With low correlation levels, opportunities should be present for active managers to find alpha and begin outperforming their benchmarks once again. With higher return dispersion, active managers will have an increased opportunity to pick winning stocks. If correlations continue this pattern, it should be easier to identify successful active managers rather than those who have ridden the macro trends of the market in recent years. If nothing else, falling correlations within the index provide an opportunity for active managers to recover from general underperformance versus the benchmark which has plagued them in recent years.