Martjin Cremers, a professor at Yale, and his colleague, Antti Petajisto, authored a paper on the concept of active share. Advisor Perspectives recently interviewed Mr. Cremers to ask about his research. (This link is worth checking out, as it has links to additional articles such as From Yale University: New Research Confirms the Value of Active Management and Compelling Evidence That Active Management Really Works.)
Active share is a holdings-based measure of how different the holdings in an active portfolio are from the benchmark portfolio. As an example, an S&P 500 index fund would have an active share of 0%, since the holdings would be identical to the benchmark. Portfolios with low active shares around 20-60% are still so close to the benchmark that they are considered closet indexers.
Where Cremers and Petajisto differ from the establishment is that by segmenting managers in this way, they believe they are able to identify a subset of managers–those with high active share–who can outperform the benchmark over time.
That result is probably the most controversial. We find significant evidence, in our view, that a lot of managers actually do have some skill.
What I find refreshing about their approach is their willingness to examine aggregate data more thoroughly. In aggregate, their data also shows that fund managers do not outperform the benchmark. Most studies stop there, pretend not to notice that numerous tested factors show evidence of long-term outperformance, and then advise investors to buy index funds and to forget about active management.
Cremers and Petajisto were not content to take the lazy road. And, in fact, when looked at in more granular fashion, the data tells a different story. Closet indexers do worse than the market, but many managers with high active share show evidence of skill. This is much more in accord with other academic research that shows that broad, robust factors like relative strength and deep value can outperform over time. A manager that pursued such a strategy would have high active share and would have a good chance of long-term outperformance. That’s exactly what our systematic relative strength strategies are designed to do.
—-this article originally appeared 2/10/2010. Last week, another well-known pundit was advancing the results of their study, which showed that managers do not outperform the market. They also took the lazy road, claiming that investors should just buy index funds. The truth is more nuanced, as Cremers and Petajisto show. There are several tested return factors that show long-term outperformance, such as value and relative strength. Managers pursuing a factor-based strategy would be likely to have high active share, and according to Cremers and Petajisto, might be just the type of manager that shows evidence of significant skill.