Active-Share Study

Active-share study refers to an academic study conducted by researchers from the Yale School of Management in 2006. The study examined how much a mutual fund’s holding differed from its benchmark, with the difference referred to as the active share. The greater the difference between the asset composition of the fund and its benchmark, the greater the active share.

According to the study, “How Active is Your Fund Manager? A New Measure That Predicts Performance,” by finance professors Antti Petajisto and Martijn Cremers, there is a positive correlation between a fund's active-share value and the fund's performance against its benchmark.

Active share is the fraction of a fund’s portfolio holdings that deviate from the benchmark index. The active share of a mutual fund ranges from zero (pure index fund) to 100 percent (no overlap with the benchmark). Active management has traditionally been measured by tracking error, which measures the volatility of portfolio return relative to a benchmark index. Petajisto and Cremers’s method used active share in conjunction with tracking error to give a comprehensive picture of how active a fund is in the dimensions of both holdings and returns.

The active-share study provocatively found that one-third of actively managed mutual funds were “closet indexers.” Closet index funds are actively managed funds that closely mirror the holdings of their benchmarks while still charging active-management fees.

The method of measuring an active fund using both tracking error and active share allows funds to be characterized by how much and what type of active management they practice. Funds with high active share and low tracking error are diversified stock pickers (e.g., T. Rowe Price Small Cap); low active share and high tracking error are factor bets (e.g., Investment Co. of America); high active share and high tracking error are concentrated stock pickers (e.g.. Fidelity Low Price); low active share and low tracking error are closet indexers (e.g.. Fidelity Magellan); and zero active share and zero tracking error are pure index funds (e.g., Vanguard 500).

The study confirmed the conventional wisdom that smaller funds were more actively managed, while a significant number of large funds, particularly those with more than $1 billion in assets under management, were closet indexers. The study’s authors stated that as measured with active share, active management predicts fund performance. Funds with the highest active share significantly outperformed their benchmarks both before and after expenses, and their returns were consistent from year to year. Funds with the lowest active share underperformed after expenses.