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LONDON, June 27 (Reuters) - The hunt for returns in trendless stock markets is pushing institutional investors back towards actively managed equity funds, offering relief to an industry that has borne the brunt of the surge in popularity of low-cost exchange traded funds (ETFs).
With European stock correlations - or the tendency of share prices to move up and down together - at their lowest in a decade, much-improved balance sheets at European companies, and volatility remaining stubbornly low, the environment for stock-picking is hitting a sweet spot.
And large asset allocators such as private banks and the investment arms of big insurers are responding.
A recent survey by State Street showed active equity fund managers to be the second most popular destination for assets over the next three years, well above their passive peers.
ABN AMRO Private Banking, which manages about $225 billion, is increasing its exposure to actively managed funds, while Zurich-based Swisscanto Asset Management with $67 billion of assets expects its actively-managed products will outperform.
"If you want to hunt for outperformance, it's better to be more active. You are potentially taking more risk, but also grabbing the return that goes with it," said Didier Duret, global chief investment officer at ABN-AMRO Private Banking.
One factor that hurt the performance of stock pickers was high correlations - a characteristic of periods where macroeconomic or top-down factors such as central bank easing or the euro zone crisis have a outsized impact on asset prices.
That pushed investors towards ETFs that passively follow indexes at cheaper fees.
But now, stock correlations, along with volatility, have slumped.
The link between share prices for the constituents of the Stoxx 600 and the index is at its weakest in a decade.
Markets awash with liquidity are exhibiting low levels of volatility not seen since before the credit crisis of 2008.
"Low volatility makes macro trading opportunities more difficult but it also heralds a new set of opportunities within equities," say strategists at Goldman Sachs in a note.
Passive investments, that tend to work well immediately following market troughs, are not looking particularly attractive at a time when benchmarks indices, while at multi-year highs, appear to be stuck in neutral.
Underneath the surface, however, the churn is substantial as investors have swung back and forth from cyclicals to defensives, from core Europe to the periphery and from volatile tech stocks to more staid examples such as consumer staples and banks.
An analysis of performance data from Lipper for about 1,600 European equity funds managing at least $500 million shows that 83 percent of these have bettered the returns of Europe's Stoxx 600 index over the past year.
The top 30 funds have, on average, risen 43 percent and handily outpaced the 14 percent run-up for the European benchmark.
Goldman Sachs strategists say the focus for the next five years in Europe for stock returns needs to shift to stock selection within sectors where company-specific factors are going to increasingly drive performance.
"In short, we have moved from a macro to a micro market." (Reporting by Vikram Subhedar and Atul Prakash; Editing by Toby Chopra)