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Hyper-Active Share

Summary

One of the features of an interesting and volatile start to 2015 has been the increasing number of references to ‘Active Share’. The asset management business loves an acronym or a two word phrase, last year ‘Smart Beta’ was on our screens on a regular basis although as we wrote in a previous blog (‘Smart Active’) on October 1 2014, we prefer active asset allocation and active managers. Index investing is after all, like driving a car only looking in your rear-view mirror.

One of the features of an interesting and volatile start to 2015 has been the increasing number of references to ‘Active Share’.  The asset management business loves an acronym or a two word phrase, last year ‘Smart Beta’ was on our screens on a regular basis although as we wrote in a previous blog (‘Smart Active’) on October 1 2014, we prefer active asset allocation and active managers.  Index investing is after all, like driving a car only looking in your rear-view mirror.
But as we also said here in ‘Size (still) Matters’* (June 2014), these creative phrases are normally associated with large-scale managers coming up with concepts that either attempt to validate their style of active management or undermine them in the case of passive or semi-passive strategies. So large funds are emphasising that while they may own a high number of index components, their variation on the weights they own gives them a meaningful Active Share.
One could be forgiven for thinking that the term ‘Active Share’ is a recent phenomenon but the term has been around since 2006 when it was presented in research by Martijn Cremers and Antti Petajisto of the Yale School of Management to examine the extent of active management as a tool for outperformance of a benchmark.
Active Share is a measure of the percentage of stock holdings in a manager’s portfolio that differ from the benchmark index. Examining 2,650 funds from 1980 to 2003, Cremers and Petajisto found that the highest ranking active funds, 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 researchers concluded that managers with a high Active Share outperform their benchmark indices and that Active Share significantly predicts fund performance hence the desire for today’s active managers to align themselves with Active Share and reinforce their raison d’être.
The Yale study also found that funds have historically tended toward a low Active Share. The study found that the percentage of assets under management with an Active Share of less than 60% increased, from 1.5% in 1980 to 40.7% in 2003. Correspondingly, the percentage of fund assets with an Active Share greater than 80% went down, from 58% in 1980 to 28% in 2003.  It is most probably the effect of growing fund sizes at work here; the bigger the fund – the harder to maintain a difference to the benchmark.  The growth of index funds to compete at lower fees against those index-huggers has no doubt brought about the re-emergence of Active Share from its research-led inception nearly ten years ago.
Importantly, the authors of the Yale Study also found that Active Share and excess performance is higher among funds with fewer assets under management – size matters!
At T. Bailey our focus is on managers who invest with conviction and where asset size is not a constraint on their management. Many of them are rewarded first and foremost by their returns not the amount of assets under management and will close their strategy if they feel the investment proposition is likely to be compromised.
Active Share is just one metric we look at along with upside and downside market capture, volatility of returns, downside protection in absolute terms and importantly how managers correlate with each other in our portfolios; all with a view to determining the appropriate risk undertaken to deliver the expected return.  Our managers’ high conviction, index-agnostic style of investing naturally translates into a high Active Share; amid the recent hype, we do not view Active Share as a ‘new religion’ rather a by-product of an investment proposition not hindered by size.

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