Using active share to measure performance

Many industry observers point to studies suggesting a majority of active managers can’t beat the index when fees charged to investors are taken into account. This has led to claims that active equity fund managers aren’t worth the cost.

But a new metric, called Active Share, developed by Yale researchers K. J. Martijn Cremers and Antti Petajisto, suggests a problem with these studies.

Active share measures, in percentage terms, how much a portfolio deviates from an index. The metric shows that about a third of U.S. mutual funds claiming to be actively managed actually follow a passive style and overlap their benchmark indices. Further, it found only a quarter of active funds are truly actively managed.

So, the reason many funds labelled as actively managed don’t beat the index is because they are, in fact, too similar to the benchmark. By contrast, funds with a high active share – significant deviation from index weightings – tend to outperform.

Bottom line, many funds don’t beat the index because their managers are what some investment industry observers call closet indexers.

Staff

The staff of Advisor.ca have been covering news for financial advisors since 1998.