Active share – a valid measure to evaluate funds?
Detlef Glow, head of EMEA Research at Lipper analyses whether active share is a reliable tool to identify actively managed investment funds.
Active share is a measure that has been used in the investment industry for awhile, but since the discussion of actively managed funds that are so-called index huggers is on the rise, this measure has become very popular. But, does active share truly help identify active funds?
What is active share?
Active share is the usual method for comparing the performance of a fund with its benchmark to find differences in the risk/return profile of the pair. But these ratios don’t tell the full story, since they do not look at the portfolio holdings. Instead, active share measures the percentage of the fund’s holdings that differs from the constituents of its benchmark/index, either by name or percentage of the weighting in the portfolio versus the benchmark. A higher active share is seen as being better, since research shows that funds with a higher active share are more likely to outperform their benchmarks. These findings are one of the reasons active share has become so popular, but from my point of view it has been overlooked that the numbers are averages, meaning there are also funds with a high active share that underperform their benchmark. Active share doesn’t tell anything about the quality of the active decisions made by the portfolio manager.
Pitfalls of the active share
Even though it sounds very simple to analyze the holdings of a given fund versus its benchmark, it can be very tricky to get results that matter. The first pitfall is the data quality, since it only makes sense to compare different datasets when the data are of high quality. One of these issues is the date on which the datasets are derived, since that may lead to larger differences in the holdings.
Another pitfall with regard to the quality of the data is the fact that derivatives within the fund portfolio need to be classified correctly in order to measure their impact within the active share.
But these are not the only pitfalls from the data input. Often, it is overlooked that a fund by definition of its investment style and /or investment objective may invest in a given market/investment universe, but it does not follow a common benchmark at all. This may lead to a high active share, when it is in fact only misdirection.