Dispersion in Equity Markets

Navneet Kumar

February 3, 2021

When stock returns are more spread out, that creates more opportunities for active managers. When dispersion of returns is tighter, there are fewer opportunities.

The charts below show equity-return dispersion in developed (DM) and emerging markets (EM) using a common measure known as cross-sectional volatility (CSV). Over the last 25 years, dispersion of stock returns (CSV profiles) were higher in EM compared to DM most of the time. This is consistent with previous research that found greater outperformance potential by active managers in EM.

We had two key findings. First, we found that dispersion of returns followed the market cycle: In more turbulent markets — when dispersion increased — managers had greater potential to outperform. Second, we found that in both regions, stock-specific contributions were lowest during times of financial distress, as correlations among stocks rose. Overall, the majority of dispersion (60% to 90%) was explained by stock-specific contribution — as opposed to common factors such as country, industry and styles (see the second line in both charts).