Active fund management and crosssectional variance of returns

Abstract

In active portfolio management, fund managers seek to follow an investment strategy with the objective of outperforming an investment benchmark index. Opportunities to outperform a benchmark in active fund management is made possible through crosssectional dispersion of returns in the market. It is cross-sectional volatility of returns that allows fund managers to identify changing trends in market relationships and to take advantage of market opportunities.Quarterly active share and active return data of Domestic General Equity funds was used to determine whether the level of active share and active return has a correlation with volatility measures such as cross-sectional variance of returns or the South African Volatility Index (SAVI). The actively-managed funds’ outperformance of the benchmark index during periods of differing cross-sectional variance was also looked at. Lastly, the possibility of whether market volatility can be used to inform fund investment decisions was also examined.The findings in this study are that there is no significant relationship between the crosssectional variance of returns, active share and active returns. In measuring fund performance in times of differing cross-sectional dispersion and breaking the analysis period into such intervals rather than as a continuous time series, active funds outperform the benchmark index during periods of low and moderate cross-sectional variance. The SAVI can be used as a fairly accurate and readily available approximation of cross-sectional variance.