‘Active share’ is a mathematical measure of the difference between the holdings of a portfolio and an index. It calculates the percentage of a portfolio’s holdings and weights that deviate from the holdings and weights in the corresponding index. A fund with 0% active share is essentially a replica of the index. A fund with 100% active share would have no holdings in common with the index.
Why is active share useful?
Martijn Cremers and Antti Petajisto of Yale School of Management introduced the term ‘active share’ in their seminal 2006 paper. One of the main findings from their study of 2,650 funds covering data from 1980 to 2003 was that those funds with the highest active share beat their benchmark by 1.49%-1.59%1 . It led many to conclude that actively managed equity funds can play an important role in an investor’s portfolio.
Additional research in 2013 took this a step further, saying that funds with an active share of 60% or less tend to generate very similar returns to the index, but may charge a higher fee relative to, for example, an index fund2 . These types of funds are sometimes referred to as ‘closet indexers’ or ‘closet trackers’3.
The conclusions drawn from both of these studies point towards the notion that higher active share may contribute to increased return potential within a portfolio. It follows that active share may therefore help investors determine what they are paying for when they select an active manager.
How does active share relate to performance?
Active share is certainly a useful tool for evaluating fund manager skill. However, it can be impacted by a variety of factors.
Not every active manager in every situation will be able to outperform or positive performance. Moreover, different market capitalizations and investment categories may also affect the active share percentage. Investors should therefore consider a variety of risk and performance metrics when choosing a manager.
What’s clear is that the debate on active share and its relationship with performance is ongoing. Studies from researchers like Cremers continue to refine and reshape the arguments.
In his 2015 study, for instance, Cremers concluded that it is not enough for active managers to just take high active share to beat a reference index – or if their fund is managed to a benchmark, their benchmark index. They also need to take a patient approach4 – meaning they trade infrequently.
In short, skilled managers, who follow a disciplined process and – crucially – have a patient investment approach, while selecting holdings that diverge from a reference index, have the ability to generate better returns than the index over the longer term.
1 Martijn Cremers and Antti Petajisto, ‘How active is your fund manager’, International Centre for Finance, Yale School of Management, 2006.
2 Antii Petajisto, ‘Active share and mutual fund performance’, Financial Analysts Journal, CFA Institute, 2013.
3 Portfolio managers, who employ a strategy similar to the benchmark while also achieving similar returns, but charge a fee for active management.
4 Martijn Cremers and Ankur Pareek, ‘Patient Capital Outperformance: The Investment Skill of High Active Share Managers Who Trade Infrequently’, The Journal of Financial Economics, 2015. Study analysed a sample of equity mutual funds from 1990 - 2013 and institutional portfolios from 1984 - 2012. Results may vary when analysing different time periods.
Past performance is no guarantee of, and not necessarily indicative of, future results.
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