Tuesday, 10 June 2014 - 20:00

 

Charts

Seed Weekly - Active Share

Active share has emerged as a new metric to assess active managers. The metric focuses on how individual stock weights in a portfolio differ from the weights in a benchmark, providing an enhancement over traditional measures such as tracking error. Simply said, active share is the fund’s percentage that is different from its benchmark. By looking at the active share you can determine if the manager is doing active stock selection or secretly hugging the benchmark.

Active share is calculated by summing the absolute difference between a stocks weight in the portfolio and the index and then halving the value and ranges from 0% (100% overlap with benchmark) to 100% (zero overlap with benchmark).

The chart below shows the stock selection of two funds and the index (benchmark) weight of the stocks.

From the chart we can see that Fund 1 is much more active in stock selection and weighting compared to Fund 2. Fund 2 is an example of closet indexer or benchmark hugger. Practically, Fund 1 has an active share of 60% and Fund 2 has an active share of only 10%.

A closet indexer is an ‘active’ manager that only takes small relative positions when compared to the index that is used as the benchmark. The returns of these funds will, gross of fees, typically be similar to that of the benchmark, but below the benchmark after fees are deducted. These managers tend to shy away from making high conviction investments which would differentiate them too far from the benchmark.

Bank Credit Analyst (BCA) looked at the active share of all equity unit trusts in the US over the last 34 years. The funds were grouped into bands by active share. They discovered that, over time, there has been an increase in funds that are closet indexers.

To get returns different to the index, a fund needs to be positioned differently to the index. The research done by BCA showed funds that outperformed the index also had a high active share.

BCA also took a look at the relation between active share, fund size and outperformance. The chart below shows the relative performance of funds broken up into fund size and active share.

From the chart we can see that small active funds had, on average, the highest outperformance. The chart also interestingly shows that fund size doesn’t have a material impact on relative performance, but that active share is a more valuable measure of whether there will be outperformance. Naturally, as a fund gets larger it becomes more difficult to retain a high active share.

While active share is very useful, it is simply another tool that should be added to an investor's toolbox for use in evaluating investment portfolios (unit trusts, segregated accounts, pension funds, etc). As the research becomes more widespread we expect that more emphasis will be placed on active share, making it more accessible for the average investor. It is currently very difficult for the average investor to calculate active share for a range of local equity managers. The key take out is that funds that are closely aligned to an index will struggle to outperform after costs.

Due to the concentrated nature of the local market we expect that South African funds will have a lower active share when compared to global funds. Globally, active share should be above 80% for a fund to be considered ‘active’, locally we expect it to be above 70%. At Seed, when allocating client investment to an active manager, our preference is for an active share consistently in excess of 75%.

Kind regards,

Gerbrandt Kruger

www.seedinvestments.co.za
info@seedinvestments.co.za
021 914 4966

Tue, 10 Jun 2014

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