Active share: are you seeing the whole picture?

Active share is increasingly being touted as a way of identifying which fund managers provide higher returns. Others, however, warn strong returns can never be attributed to one single factor. Sebastian Cheek reports.

“Active share can only really be considered in the context of other factors. Without the presence of skill, a manager that looks like a lion based on their active share might actually manage like a lamb.”

Hermes Investment Management

As investors continue to distinguish what constitutes true alpha, active managers are being scrutinised over their ability to prove added value rather than simply hugging benchmarks.

One such method which has received considerable attention is active share which, at its core, is a percentage measure of how much an equity portfolio differs from its benchmark. Advocates believe a high active share is a sure-fire way to increase risk-adjusted returns. Others, however, warn the measurement is too narrow in its view.

Although active share has become a buzzword of late, the term was first coined in a 2009 research paper entitled: ‘How Active is your Fund Manager?’and written by Martijn Cremers and Antti Petajisto.

The paper found managers with a higher active share tend to be more consistent in generating high returns against the benchmark, which implies that funds with a higher active share have more skilled managers and are more likely to outperform.

Cremers and Petajisto found the best performers, historically, have been diversified stock pickers with high active share and low tracking error, followed by concentrated stock pickers with high active share and high tracking error. The worst performers, meanwhile, have been managers with low active share and high tracking error. They examined 2,650 funds from 1980 to 2003 and found those with an active share of 80% or higher beat their benchmark indexes by 2-2.71% before fees and by 1.49-1.59% after fees.

The data sounds compelling, but a growing number of industry voices believe although active share is a useful tool for indicating how ‘active’ a manager is and weeding out ‘closet indexers’, using it in isolation fails to take into account a manager’s skill and other ingredients for portfolio construction.

There are also some who question the data. Majedie Asset Management chief executive Rob Harris points to the fact most of the analysis to date has been skewed by “survivor bias”.

He explains: “Those funds that have taken bigger positions against the index which have worked well would be included in the data set, but those which have also taken big positions against the index but which have gone wrong, have probably been shut and been excluded from the data.”

Similarly, AQR Capital Management principal Andrea Frazzini says the data does not provide solid evidence of a drastic difference between high active share and low active share fund returns.