Investing With The Herd Comes At A Price

The rise of passive investing (for example, investing through ETFs that track an index) has created a decline in the equity market stock dispersion. As a result, equity markets have become more efficient with leaner pickings for stock pickers. This trend has occurred across US large, mid and small caps - as per the chart below - and will inevitably continue as passive investing grows in scale through into the next cycle.

Digging further into the indices, the decline in average stock dispersion has been greatest in large cap stocks and therefore is the most pronounced when looking at the S&P 500. This is where the trend to passive investment has been the most pronounced, with resulting ramifications for brokers and hedge funds. By contrast, mid and small caps stocks remain less efficient. They have been less impacted by passive investing vehicles such as ETFs, even though the level of efficiency across this group of stocks has increased compared to historical levels.

At this point in the cycle, our US exposure is focused on the small/mid cap end of the market as we prefer high alpha strategies with deep stock research that can withstand high market volatility. Chasing outright beta in the large cap space is too risky given the large number of unknowns and the overall noise that is currently present in global investment markets.