A famous American football coach once said, “You don’t rise to the occasion, you sink to
the level of your training.”1 The implication is that, in times of great stress, the most
reliable recipe for success is sticking to a set of fundamental principles.
From February 20 to March 20, the S&P 500 Index returned –37.4%, with daily returns
ranging from –12.0% to +9.4%. A drop of nearly 40% in the stock market combined with a
spike in volatility can make many investors reconsider their investment approach. Some
might suddenly find stock-picking approaches more alluring. After all, who has not heard
the claim that a volatile market is precisely the environment in which many traditional
active managers thrive? But is there any truth to this claim?
To explore this issue, we looked at the performance of active US mutual fund managers
over the past two decades. We considered two different ways of measuring stock market
stress: market volatility (or how much stocks rise or fall in a given month) and return
dispersion (or the range of returns across all US stocks). In each case, active managers
underperformed their index benchmarks.
Please see the end of this document for important disclosures.
Exhibit 1 Average Excess Monthly Returns for Active US Equity Mutual Funds 1/1999—12/2019
Sample of active managers consists of mutual funds categorized as active US equity by Morningstar. Fund returns are
average returns computed each month, with individual fund observations weighted in proportion to their assets under
management (AUM). Index benchmarks are those assigned by Morningstar based on the fund’s Morningstar category.
Benchmark returns used in the excess return calculation are averages computed each month by weighting in proportion to
each fund’s AUM. The sample period is split into two groups: months with standard deviation of daily returns in the top
half and bottom half (left panel) and months with cross-sectional stock return dispersion in the top and bottom half (right
panel). Daily returns used for standard deviation calculation are from the Fama/French Total US Market Research Index.
Cross-sectional dispersion computed across all US common stocks. Details on the index can be found on Ken French’s
Another way some investors might react to a falling market is jumping ship and selling
out of stocks. The intuition may be that sitting out of the market for a period of time can
help avoid further losses. However, the data suggest this type of market timing may
instead reduce investors’ gains over time. Exhibit 2 illustrates this point using
hypothetical timing strategies that switch from US stocks into US Treasury bills after
market downturns of various magnitude and switch back to US stocks following different
lengths of time out of the market. Compared to the market’s long-term annualized return
of 9.57%, nearly all of the timing strategies underperform the simple buy-and-hold
Exhibit 2 Hypothetical Timing Strategies Withdrawing from US Stocks After Downturns US Stocks, 7/1926— 12/2019
Performance shown is hypothetical and for illustrative purposes only. The performance was
achieved with the retroactive application of a model designed with the beneft of hindsight; it
does not represent actual performance and it does not take into account any individual
investor circumstances. Hypothetical performance does not refect trading in an actual
portfolio and may not refect the impact that economic and market factors may have had on
trading decisions. Market represented by Fama/French Total US Market Research Index. Details on the index can be found on Ken French’s
website: http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html. Downturns are defned as
the frst instance of a cumulative return meeting the -10%, -20%, or -30% threshold following a day when the index has
reach’s a new all-time high level. Timing strategies switch from the US stock market (represented by the Fama/French
Total US Market Research Index) to One-Month US Treasury Bills (represented by the IA SBBI US 30 Day TBill TR USD
provided by Ibbotson Associates via Morningstar Direct) following each downturn and switch back to the market following
the number of trading days denoted. Past performance is not a guarantee of future results. No costs included.
Should these results be surprising? One of the challenges with trying to outguess
markets is the unpredictable nature of outcomes. For example, how many pundits would
have expected the equity market in China, ground zero for the COVID-19 outbreak, to
outpace global equities2 by over 10% year to date, as of March 31?
Financial downturns are unpleasant for all market participants. Investors can reduce
exacerbating the experience by adhering to core principles. Two such principles
supported by a long history of research are broad diversification and maintaining a
consistent asset allocation. Investors who deviate from these principles by pursuing stock
picking or market timing may undermine their ability to achieve their investment goals.
The hypothetical performance was achieved with the retroactive application of a model designed with the beneft of hindsight; it does not represent actual investment performance. Backtested model performance is hypothetical (it does not refect trading in actual accounts) and is provided for informational purposes only. Past performance, including hypothetical performance is not an indicator of future or actual results. The information in this document is provided in good faith without any warranty and is intended for the recipient’s background information only. It does not constitute investment advice, recommendation, or an offer of any services or products for sale and is not intended to provide a suffcient basis on which to make an investment decision. It is the responsibility of any persons wishing to make a purchase to inform themselves of and observe all applicable laws and regulations. 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