Evaluating active managers and Active Share - Good Returns (2023)

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No two active fund managers are the same.

Friday, February 5th 2016, 10:20AM

by Harbour Asset Management

They differ in style, strategy and how much risk they take. These differences also lead to differential investment performance. To understand how, and whether, active managers are genuinely adding value, investors need to break fund returns into underlying market performance, and returns generated as a result of investment manager skill.

Active Share is a risk measure that may help investors evaluate fund managers.

Active managers attempt to add value by deviating from benchmark indices. Active Share looks at the degree to which the investment holdings in an actively managed portfolio differ from those of a market index or performance benchmark. Active Share helps investors to understand and compare how much idiosyncratic risk is in a fund.

A low Active Share indicates that a fund manager is closely following an index, while a high Active Share indicates the fund manager is choosing investments that differ from the exposures in the fund’s benchmark. For example, a New Zealand equities fund that owns the same holdings, in the same proportions, as its S&P/NZX50 index benchmark would have an Active Share of 0%. A New Zealand equities fund that holds stocks that are completely different from those in the index would have an active share of 100%.

Tracking error volatility, often simply called tracking error, is the traditional measure used to assess active management. Active Share and tracking error emphasise different aspects of active management. Tracking error measures the volatility of the fund that is not explained by movements in the fund’s benchmark index. Active Share quantifies active management at the holdings level and mostly measures manager risk in terms of stock selection. Tracking error is a returns based measure, and is a proxy for systematic factor risks such as tilts to sectors, industries, macro trends and market timing. By measuring active management using Active Share, investors can get a clearer understanding of what exactly a manager is doing to drive performance, rather than drawing conclusions from observed returns.

Some investors are looking to invest in funds that have a high Active Share content as markets become more volatile and to avoid high cost ‘closet indexing’ funds (managers who claim to be active, and charge active fees, but whose portfolios are very similar to the benchmark portfolio). Research by Martijn Cremers and Antti Petajisto of the Yale School of Management indicates that US fund managers with high Active Share outperform their benchmark indexes, both before and after expenses, and that Active Share significantly predicts fund performance. Their research also notes that US Funds with medium or low active share show indifferent performance to underperformance versus benchmark indexes over time, particularly after allowing for expenses.

Investing very differently from a benchmark can contribute to a fund performing better than its benchmark – or worse. Active Share does not show that holding deviations from benchmark index exposures will necessarily deliver better outcomes for investors. Funds with a high Active Share may have a greater dispersion of upside and downside risk. Active Share is not a complete measure of risk. Active Share does not account for portfolio construction, concentration of positions or diversification. For example, including small illiquid stocks or developing businesses in an equity fund will have a higher risk than a large defensive liquid stock with the same size “active” position.

Fund’s with a high tracking error don’t always have a high Active Share – they could be using factor tilts rather than stock selection to generate outcomes. Funds with high Active Share don’t always have high tracking errors – they may be holding idiosyncratic investments that have low non-systematic risk.

(Video) How active is a portfolio manager? Active share explained (Excel)

Figure 1 is a stylised comparison of different management approaches, and how they compare in terms of Active Share and tracking error. To provide a local example we have included the positioning of three different equity strategies managed by Harbour Asset Management.

Evaluating active managers and Active Share - Good Returns (1)

Active Share is measured at a single point in time and needs to be calculated at the portfolio level regularly to be useful. It is difficult to calculate without a detailed data set and it can be cumbersome to create a series going back in time. Active Share may not provide a consistent comparison across different benchmarks and investment mandates.

But perhaps the key benefit in calculating Active Share for investors is that it exposes fund risk changes over time. Risk change over time, as measured by Active Share, could be part of a manager’s strategy. But risk change could indicate style drift (for example becoming more index aware), behavioural biases (for example risk aversion) or excessive risk taking incentives. Any of these changes may deliver investment performance that is very different from what the fund has generated in the past.

Investors can’t make decisions about manager skill or return potential using the Active Share measure alone. Investors considering investing in funds that purport to have a high Active Share component need to have a good understanding of the fund managers investment process and team. Importantly investors need to know whether the fund’s investment approach has been used consistently over a reasonable period of time and whether there has been any changes made to the fund’s investment process.
Investors also need to understand the funds risk profile relative to their own risk tolerance and relative to a reference benchmark (if they are using one). High Active Share funds should exhibit a degree of diversification and investment liquidity (ability to realise investments) that is consistent with investor objectives.

The development of the New Zealand capital market over the last few years gives fund managers a wider range of investment options from which to deliver Active Share. The introduction of new companies to the New Zealand market that may have return profiles that are very different from the broader market, and a broader range of fixed interest investment options, give fund managers a greater range of investments from which to create funds than was the case five years ago.

Active Share combined with tracking error and other measures can give investors a lot of information regarding risk and the style of a fund’s investment strategy. Active share is a useful metric to add to investors fund analysis tool kit especially as a comparison measure between funds over time. But to truly prove that managers with a high Active Share can persistently deliver better outcomes investors need to understand underlying investment processes and teams.

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Tags: Harbour Asset Management

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What is a good active share number? ›

Exhibit 1

The authors established that an Active Share of 60% or higher is generally considered active management. An Active Share of 20% to 60% is considered closet indexing, and an Active Share of less than 20% is considered passive (Exhibit 2).

What percentage of active managers outperform? ›

The S&P Indices versus Active (SPIVA) scorecard, which tracks the performance of actively managed funds against their respective category benchmarks, recently showed 79% of fund managers underperformed the S&P last year. It reflects an 86% jump over the past 10 years.

Is high active share good? ›

Active Share is a measure of the percentage of stock holdings in a manager's portfolio that differs from the benchmark index. Managers with high Active Share have been found to outperform their benchmark indexes. The conclusion drawn by the study is that Active Share significantly predicts fund performance.

How do you measure active share? ›

Active share is calculated by totaling the absolute value of the differences between the weight of each position in the portfolio and the weight of each holding in the benchmark and dividing by two.

Can active share be more than 100%? ›

It can also be achieved by purchasing non-benchmark securities. For a strategy that does not short stocks and does not purchase stock on margin, active share will always be between 0% and 100%. In contrast, the active share of a hedge fund strategy can exceed 100% due to its use of leverage and short positions.

Does active share matter? ›

Due Diligence Matters

The Relative Active Share metric allows investors to better understand how high or low a fund's active share is in the context of a category. The full study found no consistent link between the level of active share and propensity to outperform.

Do active managers outperform passive? ›

Active management has typically outperformed passive management during market corrections, because active managers have captured more upside as the market recovers.

Do actively managed funds outperform? ›

Just four bond categories outperformed over a 10-year period and none over 15 years, according to the S&P report. Just 26% of all actively managed funds beat the returns of their index-fund rivals over the decade through December 2021, according to a separate report published last month by Morningstar.

Why do actively managed funds underperform? ›

Actively managed funds start at a disadvantage when compared to index funds. The average ongoing management expense of an actively managed fund costs 1% more than its passively managed cousin. The expense issue is one reason why actively managed funds underperform their index.

What does Active Share indicate? ›

Active share is a measure of the difference between a portfolio's holdings and its benchmark index. Mathematically, it is calculated as the sum of the difference between the weight of each stock in the portfolio and its benchmark weight, divided by two.

Why should we care about Active Share? ›

It addresses whether Active Share can help identify closet trackers, it helps investors avoid underperformance by identifying funds with low Active Share and high expenses, and it is useful for picking funds with high Active Share.

What is meant by active return? ›

What Is Active Return? Active return is the percentage gain or loss of an investment relative to the investment's benchmark. A benchmark might be market comprehensive, such as the Standard and Poor's 500 Index (S&P 500), or sector-specific, such as the Dow Jones U.S. Financials Index.

What is a good information coefficient? ›

Generally speaking, many portfolio managers would view a “good” IC as 0.05 and a “very good” IC as 0.10.

Is Active Share the same as tracking error? ›

Active share measures the percentage of an active portfolio that is different from its respective benchmark. Tracking error is a common risk metric that measures the volatility of relative returns an active manager has realized compared to his/her fund's benchmark.

What is the benchmark index? ›

What is a Benchmark Index? A benchmark Index is a group of securities used in measuring the performance of other stocks or securities in the market. The Dow Jones Industrial Average, the S&P 500, or the Russell 2000 are examples of benchmark indexes.

Does Active Share include cash? ›

All other security types such as cash, bond, warrants and derivatives are excluded.

What is a smart beta strategy? ›

Smart beta strategies seek to enhance returns, improve diversification, and reduce risk by investing in customized indexes or ETFs based on one or more predetermined "factors." They aim to outperform, or have less risk than, traditional capitalization-weighted benchmarks but typically have lower expenses than a ...

What is active risk in a portfolio? ›

What Is Active Risk? Active risk is a type of risk that a fund or managed portfolio creates as it attempts to beat the returns of the benchmark against which it is compared. Risk characteristics of a fund versus its benchmark provide insight on a fund's active risk.

Where is Active Share on Morningstar Direct? ›

Click in the Search for data points field and search for active share. From the results, select Active Share to add it to the view.

How do you find the tracking error? ›

Tracking error is the standard deviation of the difference between the returns of an investment and its benchmark. Given a sequence of returns for an investment or portfolio and its benchmark, tracking error is calculated as follows: Tracking Error = Standard Deviation of (P - B)

What does gross exposure mean? ›

Gross exposure refers to the absolute level of a fund's investments. It takes into account the value of both a fund's long positions and short positions and can be expressed either in dollar or percentage terms.

What does Active Share indicate? ›

Active share is a measure of the difference between a portfolio's holdings and its benchmark index. Mathematically, it is calculated as the sum of the difference between the weight of each stock in the portfolio and its benchmark weight, divided by two.

What is meant by Active Share? ›

Definition and uses of active share. Active share is a measure of the differentiation of the holdings of a portfolio from the holdings of its appropriate passive benchmark index.

What does it mean if a stock is active? ›

The term active stocks refers to corporate shares that are heavily traded on an exchange. Active stocks are frequently bought and sold, which means they have fairly high trading volumes. These stocks generally also have a large number of outstanding shares.

What is a good information coefficient? ›

Generally speaking, many portfolio managers would view a “good” IC as 0.05 and a “very good” IC as 0.10.


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