Return dispersion and fund performance: Australia – The land of opportunity?

We examine the relation between cross-sectional stock return dispersion and active fund performance in Australia, drawing on the concept that higher return dispersion provides greater opportunity for skilled managers to generate value. In contrast with findings using US data that outperformance occurs only for the most active funds and in the highest return dispersion environments, Australian data show that active funds earn positive returns when return dispersion is in the moderate-to-high range. We also find meaningful differences between large-cap funds, where outperformance is modest and significant only for the most active funds, and small-cap funds, where active returns are larger in magnitude and do not depend greatly on fund activeness. Applying a switching strategy between active funds and passive investment reveals that investors would be advantaged by retaining exposure to active funds in Australia in all but low return dispersion months in the absence of buy-sell spreads. However, imposing spreads eliminates the added value from switching, concluding in favour of maintaining an active exposure regardless of the dispersion environment.