Author Details

Hitendra D Varsani

Hitendra D Varsani

Managing Director, MSCI Research

Rohit Gupta

Rohit Gupta

Vice President, MSCI Research

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Active-Management Opportunities in a Disperse Market

  • There have been greater opportunities for active managers, as equity markets rotated at the fastest pace in 10 years, resulting in high cross-sectional volatility.
  • Measuring cross-sectional volatility and its decomposition in terms of factors and specific components can potentially help in budgeting risk for top-down and bottom-up allocations.
  • Overall, for top-down asset allocation, style factors offered increased alpha opportunity relative to industries and countries. For bottom-up stock pickers, emerging markets offered more opportunity than developed markets.

Global equity markets have continued to show resilience through 2021, with the MSCI ACWI Investable Market Index (IMI) returning 12.9% through June 30, 2021. While, at the surface, market volatility has subsided to levels last seen prior to the COVID-19 crisis, the patterns below the surface tell a different story. Rotations underlying the market have intensified with investors actively differentiating between stocks, industries, countries and style factors. In our earlier blog posts (Factors in Focus: Val-come Back! Shifting Factors as the Cycle Turns and Factors in Focus: Value Springs into Action), we highlighted the strong rotation between value and growth, and small caps over large caps, as well as strength in procyclical sectors from Q4 2020 through Q1 2021. What has this meant for active managers?

Historically, low overall market volatility and high dispersion among stocks has created opportunities for active management. One such measure of dispersion is cross-sectional volatility (CSV), which is defined as the standard deviation of a set of asset returns over a given period.1 This dispersion measure is of critical importance to active managers, as it represents the opportunity set. For instance, when the dispersion of stock returns has been very small, stocks, generally, have behaved similarly and there has been little opportunity to outperform the market. Conversely, when CSV levels have been high, performance differences among stocks — and active managers — have been more pronounced.


Equities Were Differentiated at the Fastest Pace in at Least 10 Years

To visualize the dispersion in stock returns through time, we plotted the CSV of the MSCI ACWI IMI and placed it in the context of the index’s 12-month realized volatility. More often than not, these two measures of risk typically moved hand in hand — particularly during crisis periods, when equity-market volatility was elevated. However, most recently, while equity-market volatility fell, the dispersion between stocks remained relatively high.


MSCI ACWI IMI Time-Series and Cross-sectional Volatility

Data from Jan. 1, 1999, to June 30, 2021

Falling correlations between stocks could explain why the dispersion remained high. In the exhibit below, we plot the trailing realized correlation among stocks that make up the MSCI ACWI IMI.2 During the 2008 global financial crisis, European debt crisis in 2011 and COVID-19 crisis last year, realized correlations surged, and then declined following the worst drawdown of each crisis. The exception was when the dotcom bubble burst between 2000 and 2002, but correlations remained low, due to strong sector rotation.

Overall, CSV has been positively exposed to stock-level volatility and negatively to correlation. These two drivers could have offset each other or magnified CSV depending on their size. In recent times, while volatility has declined, the decline in correlations has provided active managers with a steady opportunity set.


MSCI ACWI IMI Stocks’ Correlation

Data from Jan. 1, 1999, to June 30, 2021. Based on a trailing 3-month realized correlation among stocks in the MSCI ACWI IMI


The CSV can be further decomposed into contributions from factor and stock-specific components. The factor component can, in turn, be decomposed into styles, industries and countries. Looking at the respective contributions can help active managers as they decide how to distribute their allocation budget across different segments.


Dispersion from Style Factors Rose in Developed and Emerging Markets

How could active managers with a top-down allocation budget have distributed this budget across systematic factors, namely style factors, industries and countries? Highlighting where the dispersion has been the greatest among systematic factors could have helped structure asset-allocation decisions.

We looked at the individual contributions from styles, industries and countries to the overall factor contribution in the dispersion in stock returns. The exhibit below plots these contributions for the MSCI ACWI, MSCI World and MSCI Emerging Market (EM) IMI universes. We find:

  1. Style-factor contribution increased in the 12 months ending June 30, 2021.
  2. Within MSCI ACWI and MSCI World IMI, style-factor contribution overtook industries and countries in 2021.
  3. Within MSCI EM IMI, the contribution of countries was dominant, but has declined as of late.

Taken together, this provided an opportunity for active managers to tactically increase their top-down style-factor risk allocation, as compared to industries and countries, for potentially higher alpha.


CSV Contribution by Factor Groups for MSCI ACWI IMI, MSCI World IMI and MSCI EM IMI


Data from Jan. 1, 1999, to June 30, 2021


Data from Jan. 1, 1999, to June 30, 2021


Data from Jan. 1, 1999, to June 30, 2021


What About Bottom-Up Managers?

To examine trends in active opportunities from bottom-up stock selection, we can compute the stock-specific contribution to the total dispersion across MSCI ACWI, MSCI World and MSCI EM IMI. Doing so, we find:

  1. The dispersion of returns has tended to follow the market cycle. During periods of high volatility (1999 to 2002, 2008 to 2009 and in 2020), the stock-specific contributions tended to be lower, due to higher correlation among stocks, making systematic factors more important.
  2. The stock-specific contribution as a percentage of total dispersion was typically between 70% and 80% in developed markets and between 65% and 85% in emerging markets.
  3. In each region, we have seen stock-specific contributions rise recently.


Stock-Specific Contribution as % of Total Dispersion

Data from Jan. 1, 1999, to June 30, 2021


Key Takeaways for Active Managers

Disperse markets have historically provided opportunities for active managers to outperform their respective benchmarks. We showed that, based on historical trends, CSV helped shed light on identifying where the dispersion was greatest. By analyzing the CSV in more detail, we found that over the last 12 months:

  1. Despite falling market volatility, declines in stock correlations kept CSV elevated.
  2. Style factors played an increasing role in driving CSV, relative to industries and countries in both developed and emerging markets.
  3. Stock-specific contribution to overall CSV has been rising, particularly in emerging markets.

Trends in dispersion can help active managers make more informed decisions on risk budgeting among style factors, industries and countries, as well as for stock selection in their global-equity portfolios.



1CSV is calculated using monthly returns and smoothed using a 12-month moving average.

2Correlation is calculated as ρ=(σ2B- ∑ni=1(wi)2 σi2 )/(∑ni=1(wi σi)2 - ∑ni=1(wi)2 σi2 ) . Where σB2 index variance, wweight of stock i, σivolatility of stock i and n number of constituents in the index. This approach assumes that all the correlations are equal — i.e. ρ = ρij in the calculation of index variance using constituent covariances.



Further Reading

Markets in Focus webinar

Factors in Focus: Go with the Flow?

Did Pfizer Give the Value Factor a Much-Needed Shot in the Arm? podcast

Insights Gallery: The Dispersion of Stock Returns

Factors Active Role in Portfolio Construction