Stock market correlation leads to ‘closet’ indexing – InvestmentNews 09-30-12

Salient to Investors:

A fund is highly correlated to its benchmark index if its R-squared reaches 90: at 95, it is considered a ”closet” index fund.

The steady rise in correlations among all stocks is making it more difficult than ever for actively managed funds to differentiate themselves from their benchmarks.

Morningstar said that the 10 largest actively managed stocks fund in the world have an average three-year R-squared of 97, up from 83 in 2007. The average large-cap-blend fund has an R-squared of 99.7.

Brendan Clark at Clark Capital Mgmt said the underlying condition of the market is creating closet indexers.

Over the past 3 years, almost $150 billion has flowed into passive stock funds and more than $300 billion has been withdrawn from actively managed stock funds.

Kevin McDevitt at Morningstar said that while traditionally, investors want active managers to outperform the market, the differentiation from a benchmark should be more about downside protection – passive funds can’t defend themselves when the market is falling.

Read the full article at http://www.investmentnews.com/article/20120930/REG/309309989