The challenge for long-short hedge funds

An article in today's WSJ - Picking Stocks Becomes Tougher
(paid subscription required) - outlines the views of three market
strategists that ETFs make more sense now than ever. Their arguments:


Wells Capital Management strategist James Paulsen did a study of the
monthly price change of each component stock of the S&P 500 over 20
years to calculate the average difference or "dispersion" among the
individual stocks' performance. His results:

  • Dispersion in April was 7.9%
  • The all time high (mid-2000) was 20.9%
  • Recent peak (mid-2002) was 18.7%
  • The 16-year low was about 5%

Conclusion? Low dispersion means its far harder to make (and lose)
money with individual stocks. That makes indexing (including owning
ETFs) more compelling, as the cost of stock picking is even less
worthwhile.

Riley Asset Management CEO Ned Riley says he is currently investing his own money as follows:

  • 40% in SPY
  • 20% in QQQQ
  • 40% in sector ETFs

Fifth Third Asset Management strategist Jim Russell recommends that
investors use an S&P 500 fund (such as IVV or SPY) as the core of
their portfolios. He expects the S&P 500 to return about 6% this
year.

Quick comments:

  • Is low individual stock dispersion a function of asset inflows into hedge funds? There's been lots of talk about asset inflows into hedge funds increasing competition and making stock picking harder, but this is perhaps the first hard evidence of the phenomenon.
  • The decrease in dispersion is particularly notable given that Reg FD is supposed to have increased stock volatility.
  • Ned Riley's use of QQQQ is baffling, particularly given his experience as an investor.