When Volatility Rises, So Have Active Management Results

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Jan 16, 2015, 03:00 ET

NEW YORK, Jan. 16, 2015 /PRNewswire/ -- For many investors, volatility is often synonymous with risk. We as value investors (and risk managers), on the other hand, have always viewed volatility as a crucial component of active stock selection; as Warren Buffett said, "Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it."

Monthly Rolling 36-Month Standard Deviation. Russell 2000 from 12/31/81 to 9/30/14.

In our latest Research piece, we explore the relationship between low- and high-volatility environments and the relative performance of active managers versus their respective benchmarks during these periods. This deep dive is especially important in a market that has recently seen more volatility and its largest correction in almost three years. Read our full research report to learn about our findings.

"The past five years have been marked by the rare combination of a remarkable rebound in domestic equity markets and a low-volatility equity environment. This combination has proven to be difficult for domestic equity managers, as over 70% of them across all capitalization and style categories failed to deliver returns higher than their respective benchmarks." This is the conclusion of the most recent publication of the S&P Dow Jones Indices report, "S&P Index Versus Active" (SPIVA). The piece stoked our curiosity about the relationship between volatility, the recent relative performance of active managers, and the indexes they for the most part have struggled to beat.

Our commitment to the core principle of embracing volatility made us eager to test the hypothesis of the SPIVA Scorecard. We ran our own study focused on the small-cap space to determine what, if any, relationship exists between volatility and outperformance among active small-cap managers. Although there are many measures of volatility, we chose in our study to use standard deviation, looking at monthly rolling 12-, 36-, and 60-month standard deviations from the inception of the Russell 2000 Index on 12/31/78 through 9/30/14. This gave us an enormous number of data points spanning more than 35 years -- 418 for the 12-month period, 394 for the 36-month period, and 370 for the 60-month period.

Monthly Rolling 36-Month Standard Deviation
Russell 2000 from 12/31/81 to 9/30/14

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We began by sorting the annual standard deviations from highest to lowest and divided them into quintiles. For each monthly rolling period in each quintile we looked at the corresponding outperformance of the active small-cap manager versus the Russell 2000.

To read the rest of the report and learn about our findings, view our complete whitepaper now.

Important Disclosure Information

This material is not authorized for distribution unless preceded or accompanied by a current prospectus. Please read the prospectus carefully before investing or sending money. Royce Pennsylvania Mutual Fund invests primarily in small-cap stocks, which may involve considerably more risk than investing in larger-cap stocks. (Please see "Primary Risks for Fund Investors" in the prospectus.) The Fund's broadly diversified portfolio does not ensure a profit or guarantee against loss. The Fund may invest up to 25% of its net assets in foreign securities (measured at the time of investment), which may involve political, economic, currency, and other risks not encountered in U.S. investments. (Please see "Investing in Foreign Securities" in the prospectus.) Standard deviation is a statistical measure within which a fund's total returns have varied over time. The greater the standard deviation, the greater a fund's volatility. Please read the prospectus for a more complete discussion of risk. Russell Investment Group is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. Russell® is a trademark of Russell Investment Group. The Russell 2000 is an unmanaged, capitalization-weighted index of domestic small-cap stocks. It measures the performance of the 2,000 smallest publicly traded U.S. companies in the Russell 3000 index. The performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index.

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SOURCE The Royce Funds