(MoneyWatch) Active fund managers are always coming up with excuses for why they can’t beat index funds. In recent years, their excuse was that increased correlations (a measure of the strength of the linear relationship between two variables) of stocks made it difficult to outperform. Just like their other excuses, this one holds up to scrutiny about as well a sieve holds water.
Correlation shows the directional movement of stocks, not the magnitude of their movement. Magnitude is shown by the dispersion of returns, or the size of differences in the returns of individual stocks/asset classes. The greater the dispersion, the greater the opportunity for active management to add value by overweighting the winners and avoiding the losers.