Active U.S. equity strategies have generally struggled to keep pace with their passive counterparts in recent years. This comes amid a backdrop of very low volatility and an increasingly concentrated and narrow‑performing market. However, our analysis suggests that when U.S. equity markets have displayed similarly extreme characteristics—concentration, volatility, dispersion of returns—active managers have generally outperformed index returns as these extremes began to unwind.
Indeed, history shows us that opportunities for active stock picking become more pronounced when coming from extreme starting points.
A Decade of Challenging Market Dynamics
During the 10 years to 2021, a combination of extraordinary policy action and substantial passive investment flows had a distorting impact on the U.S. equity market. Macro factors and momentum became the main drivers of market performance, overshadowing the fundamental quality of individual companies.
For active managers, this proved an increasingly challenging backdrop as market factors were pushed to extremes, making opportunities for differentiated alpha generation harder to find.
Extreme Market Concentration
In recent years, the powerful gains recorded on major U.S. benchmarks have been disproportionately driven by a small number of large, growth‑oriented stocks. In 2020, for example, five stocks on the S&P 500 Index—Alphabet, Amazon, Apple, Facebook, and Microsoft—returned 55.8% for the year, while the remaining 495 stocks in the index returned 10.8%.1 The stellar performance saw the index become increasingly concentrated in these five companies, with their combined weight peaking in 2020 at 24% of the total index (based on daily data).
Few would argue that these are solid, disruptive businesses, and their respective returns reflected strong profitability and earnings growth. The ultralow interest rate environment during much of the past decade also supported the rising valuations of these companies, given their long duration growth profile. However, the extreme concentration in so few at the top of the index also reflected the distorting effect that heavy passive investment flows can have. With more money being allocated to the largest companies, the loop can become perpetual, with the index becoming increasingly concentrated as the largest stocks grow ever larger. In this scenario, momentum—rather than the underlying performance of the companies themselves—becomes the main driver of asset returns. This is a challenging backdrop for active managers who typically seek to limit portfolio concentration and so often underweight the largest and most expensive stocks.
1Source: S&P. S&P 500 Index calendar year performance, 2020 (see Additional Disclosures).
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