A study conducted by Yale University’s professors Martijn Cremers and Antti Petajisto in their 2006 public report “How Active Is Your Fund Manager?”, which shows that the actual investment portfolio differs from its benchmark index.
Active-Share Study Details
The active-share study explores the active portfolio management of mutual funds. The two professors have come up with a method to measure the percentage of actively managed funds that drive performance and have concluded that almost 28% of the funds are “closet indexers” that track the benchmark index for safety purposes. Soon after the professors published their study, the Wall Street Journal cited it in a 2007 article on how technology has influenced trading models and index-tracking.
Investor’s Business Daily addressed it in 2008. Motley Fool published a written work that deduced that active share shows the fund’s capacity to outperform its benchmark and sets a standard of how stocks stand relative to other stocks within a fund.
The study has changed the investment environment to where, in 2018, the New York Attorney General announced that thirteen companies have agreed to report their active share to retail investors before receiving capital to the fund.
Example of Active-Share Study
Active Share quantifies the degree to which you manage a portfolio actively. We calculate it by taking the sum of the difference between the weights in a portfolio and the benchmark weights. After this, we divide the result by two to ensure the Active Share measure falls between zero and one hundred percent. If the fund has an Active Share of 40%, the rest is considered the passive share representing the portfolio’s holdings and weights that directly overlap with the benchmark.
The authors set up that we should regard an Active Share of 60% or higher as active management. Intuitively, an Active Share of 20% to 60% is closet indexing, and an Active Share of less than 20% is passive. Furthermore, a portfolio that has exactly matched its benchmark has an Active Share of zero, and the one that has nothing to do with its benchmark has an Active Share of 100.
Petajisto found that for the period of the global recession of 2008–2009, funds with high Active Share outperformed their benchmark by almost 1% per year as opposed to other funds. Active share drives performance because the higher it is, the more effectively it spreads the work across a greater portion of the portfolio, reducing the overall effort needed to drive better returns.
Significance of Active-Share Study
Some mutual funds have argued that a high active-share portfolio may not always be the best option because it would require a great deal of stock tracking and patience.
According to Callan, a US investment consulting company, you should beware that active shares don’t adjust in relation to the overall market. High active share may come from non-index securities, the return of which doesn’t reflect historical performance and is temporarily higher because of regional bias, for example. Here, the return from a portfolio may seem great, but the shares’ activity may be this high only temporarily.
Moreover, experts argue that Active Share can be boosted by simply holding cash or non-benchmark securities even though it seems simple and dazzling.