Since 1991, the average correlation for actively managed mutual funds has been increasing. As of December 2011, it was at its approximate highest level in history, with the average fund having a correlation of 0.982 to its respective category index. Viewed differently, a correlation of 0.982 means that 98.2 percent of the return of a given active manager can be described entirely by the underlying benchmark index. This suggests the active manager is only adding roughly one-thirtieth of the total deviation in returns, but in many cases charging 10 times or more than what a comparable passive strategy costs. Note that the t-statistic associated with slope is 11.73, suggesting an incredibly high level of statistical significance.
Another way to view the changing “active” exposure of mutual funds through time is the standard deviation of the correlations. This metric captures the dispersion of all active managers through time. It is possible that while the average is increasing, there could also be a greater level of dispersion among portfolio managers. Unfortunately, as demonstrated in Figure 2, the average rolling category correlation standard deviations have also been decreasing. This suggests that, on average, an increasing number of actively managed mutual funds are clustering more and more tightly around their respective category benchmarks. The t-statistic associated with slope is -8.84, suggesting an incredibly high level of statistical significance.
The final test to determine the direction of the “active” portion of actively managed mutual funds is based on the average tracking error of the fund versus its respective category index (Figure 3). For this test, other than two noticeable spikes, the clear trend has been a decreasing level of tracking error through time. Again, this suggests active managers are in fact less “active” than they used to be. The t-statistic associated with slope is -3.13, suggesting a relatively high level of statistical significance.