Sometimes it feels as if markets go out of their way to find reasons to worry. As if investors did not have enough on their plates with the consistency of a Chinese landing, the US fiscal cliff and whatever new euro-horror has just ruined your day, there are now dark mutterings about tripledip recessions and whether bond funds have enough liquidity should everyone head for the exit at once.
All this, too, when most people are on holiday and markets are traditionally in the hands of a dozen or so jittery trainees and an increasingly influential master race of hair-trigger supercomputers. It is times like these when I normally prefer to duck for cover behind some aspect of behavioural finance but the idea of ‘active share’ will do just as well. Anyone thinking about investing in a fund could consider what its manager has achieved in the past or they might try and work out what the portfolio will deliver in the future. Active share helps out with the latter endeavour by aiming to quantify how much of a fund’s outperformance is down to the manager’s skill. Active share has its own mathematical formula courtesy of finance professors Martijn Cremers and Antti Petajisto but, as I would hate you to think this column had ideas above its station, let’s just say it measures how actively a fund is managed by analysing the degree to which the weightings of that fund’s holdings differ from those of its benchmark. According to Legg Mason Capital Management’s chief investment strategist Michael J Mauboussin, an active share of 60% or less is generally considered ‘closet’ index-tracking while one of 90% or more indicates a true stockpicker. Importantly, the lower a portfolio’s active share, the greater the portion delivering index-like returns – and thus the harder the manager has to work to offset the effects of fees. Now, that is something that may or may not be of interest to you but, if it is, industry trends are not in your favour. “For the past 30 years, active share has been declining steadily for the mutual fund universe in the US,” notes Mauboussin. “For instance, the percentage of assets under management with active share less than 60% went from 1.5% in 1980 to over 40% today.” As one stockpicking fund manager recently – and wearily – observed to me, however, many investors today are more than comfortable with this development because, much as 20 years back you would not get fired for buying IBM, now professional investors do not seem too bothered about losing money – just so long they lose it in line with a benchmark. Each to their own, I suppose, and indeed as Mauboussin concludes: “Passive management makes sense for a great deal of investors. But the essential message is this – if you’re going to be active, go active. Don’t own a fund with low active share because the chances are good the fund’s gross returns will be insufficient to leave you with attractive returns after fees.”
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