Active equityfund managers are staging a comeback. After years of underperformance, during which active managers lost tens of billions of dollars in assets to passive funds, during the first half of this year, over half of all US equity mutual funds outperformed their benchmarks, according to the latest flagship scorecard from SPDJI. Equity hedge funds are also doing well, gaining an average of 8.6% this year to the end of September, according to HFR. This is the strongest performance in four years from the equity hedge fund group.

US equity funds returned an average of 18.7% in the 12 months to the end of June, surpassing the broad S&P 1,500 index’s total returns of 18.1%, according to SPDJ’s report on active equity fund managers. According to an analysis by the FT, this translates into 52.5% of all funds beating their benchmarks, compared to an outperformance record of only 15% for the past decade.

Falling equity correlations have been blamed for this strong showing from active equity managers. As the Federal Reserve has embarked on its mission to try and normalize monetary policy, equity correlations have fallen, helping active stock pickers.

Equity correlations have slumped across the board this year. The decline has been so aggressive that Bernstein analysts have termed it “The Great Correlation Collapse”. Indeed, according to Morgan Stanley, the realized correlation of the US equity benchmark’s constituents is about 18%, down from roughly 60% just a year ago and one of the lowest readings since 2001.

The Great Correlation Collapse

The Great Correlation Collapse is helping active equity fund managers profit from individual equity themes such a rate rises, which would have been difficult to plan this time last year. A recent research note from analysts at Bank of America notes that rate sensitive equities, such as Financials, Utilities, and Telcos have seen correlations to rates rise substantially in recent months.For example, the correlation between the 10Y and US Financials has risen from around -0.55 over the past two years, to -0.75 in the last three months. BoA’s analysts calculate that a 10bp increase in the 10Y rate would translate on average to a 1.6% gain for Financials and a 0.9% loss for Utilities. Energy, Telcos, and Industrials could also benefit.