Global Equity Research: Decomposing Volatility

The Relationship Between Cross-Sectional Volatility and Active Management

Volatility is one of the primary risks active asset managers are tasked with managing, both on the total portfolio level as well as relative to their respective benchmarks. While investors generally prefer to minimize both total and active volatility, for a given level of return, active managers need cross-sectional volatility, or dispersion of individual equity returns in a given period, to generate alpha through stock selection. When equities are correlated and move together in tandem active managers have less opportunity to separate winners from losers, whereas when cross-sectional volatility is high, active managers may have the opportunity to reap greater rewards if they are able to correctly identify outperformers and avoid underperformers.

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