May 2012_issue_12
The number of days on which 90% of constituent stocks in the S&P 500 Index moved in one direction, whether up or down, has rocketed since the crisis began, but has also shown a steady increase over the long term. This translates into a massive increase in the correlations between those stocks and the index, as would be expected in a jittery macro-driven market. The result for many active managers is a decreased opportunity set as stocks move less on their own fundamentals than broader market sentiment, but it also signifi cantly reduces diversifi cation for all investors, whether passive or active. One quant study in Europe suggests achieving a tracking error of 3% versus the index required only around 40 stocks in 2008, but by November 2011, that had jumped to 170 stocks.
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