Are truly active managers more likely to beat the market than those who stay closer to their benchmark index? In my latest podcast, I discuss this idea with Christopher Davis, a strategist and researcher at Morningstar Canada.
The idea of active share was introduced in a 2009 paper called How Active is Your Fund Manager? A New Measure That Predicts Performance, by Martijn Cremers and Antti Petajisto. For example, a large-cap US equity fund that holds only half the stocks in the S&P 500 would have an active share of 50%. An index fund, by definition, has an active share of zero.
The researchers presented evidence that the most active funds “significantly outperform their benchmarks, both before and after expenses, and they exhibit strong performance persistence.” A year later, Petajisto published a follow-up paper called Active Share and Mutual Fund Performance, which included more support for the idea that the most active stock pickers can be expected to add value.
Both papers take aim at so-called closet index funds, which charge the higher fees one expects for active management yet differ little from their benchmark.