Since 2008, equity sector correlations have remained consistently high. As broad equity markets rallied, most, if not all, of the equity sectors moved higher in tandem with the overall market. Even then, some sectors certainly performed better than others. Traditional high beta sectors like Industrials, Financials and Technology led the market higher while traditionally low beta sectors such as Healthcare, Utilities and Consumer Staples performed well, but in line with their historical beta measures.
In early 2013, however, sector correlations decreased and historical betas started to break down. While the broad markets continued to move higher, certain high beta sectors began to lag while lower beta sectors raced higher. A significant change in a sector’s historical beta is unusual. Looking at the chart of year-to-date sector returns below, defensive sectors such as Healthcare, Consumer Discretionary and Consumer Staples were three out of the four top-performing sectors while traditionally higher beta sectors such as Materials and Technology can be found at the bottom of the list. Keep in mind this performance dispersion is within the framework of a higher trending broad market.
This decline in sector correlations and changing betas certainly creates opportunity to outperform (and underperform) for the average long-only active equity manager. One of the factors that has separated top-performing managers from others is their ability to own enough of the traditionally defensive sectors as the market has rallied. This flies in the face of traditional convention as many managers tend to overweight Industrials, Technology and Materials as markets rally and overweight Healthcare, Utilities and Consumer Staples as markets decline.
This phenomenon has had a big impact on the options market, especially for portfolio managers and traders who typically write call options in the quest to generate alpha through options writing. Why? In a word, volatility.