‘Active Share’ is a measure of how different a mutual fund is from its benchmark index. I just read a paper about it recently published in the Financial Analysts Journal (Volume 69, Number 4, 2013) of the CFA Institute. The article was written by Antti Petajisto while the author was a finance professor at the NYU Stern School of Business. Among the findings of his study, looking at mutual fund performance in the U.S. from Jan. 1990 to Dec. 2009:
- There has been an increasing trend over this time period towards ‘closet indexing’ in which actively managed funds look more and more like their index.
- The average actively managed fund underperformed its benchmark by -0.41% after fees.
- Closet indexers underperformed by -0.91% after fees.
- Managers with a high Active Share (> 80%) rating (stock pickers) outperformed by + 0.98% after fees.
- Of the groups of funds studied, smaller funds within the stock picker group had better outperformance after fees.
- In the 2008-2009 crisis, stock pickers did better than closet indexers.
Data from statistics and studies can be cherry picked and used to support almost any viewpoint. To me, it makes sense to use both passive low-fee ETFs (or intelligent index funds) and actively managed funds with a high Active Share rating. The argument about whether passive or active management is best will continue, and at times one will come out ahead while in another period the other will win. So it is my view that both have a role in a properly diversified portfolio, and that rebalancing is essential to benefit from the ups and downs of each. But if you are going to use actively managed funds, make sure that the manager is not a closet indexer and that he/she is earning his/her fees with active stock selection. If you would like a copy of the article, email me and I’ll forward it to you.