Volatility – the mother of all disruptions

We have been living through a period of disruptive change unfolding across many industries in recent years and will undoubtedly see further disruption from the current crisis. As competitive forces and technologies can drive returns down over time, it is important for businesses and investors like to ensure they are on “the right side” of the disruption. With volatility returning to the market with a vengeance, it is once again a critical time for investors to re-examine their holdings and allocations.

The resurgence of active management

International large cap equities have seen net negative flows from institutional investors in nearly every quarter in the past five years according to eVestment. Where flows have seen positive growth has been in the passive end of the market. This may seem counterintuitive given the breadth of the international equities universe and the opportunity for active managers to add value. In fact, over the past 10 years the median large cap international equity manager has delivered over 1% of annualized outperformance, whereas the median US large cap manager has trailed the S&P 500 by over 40bps annualized over the same period.

More recently there has been a notable reduction in the level of outperformance from active international equity managers with the median delivering only 56bps excess return over the trailing 3-year period. This shift may have prompted many to conclude that large cap international equities were becoming more efficient and that low-cost passive options could deliver a better overall outcome. However, that conclusion may be misplaced as the reduction in outperformance seems to be more of a function of the suppressed market volatility and return dispersion in recent years.