Active Share – the Holy Grail of fund comparison?

Active management is a way of running a portfolio in order to try to outperform an index or benchmark. It is characterised by relying on a manager's stock-picking skills, believing they have the abilities to identify the best stocks available and generate a higher return from them, thus outperforming a benchmark. These funds often have higher management fees and ongoing charges than passive/index fund managers - those who aim to match the benchmark - in order to justify the more frequent trading and deeper analysis needed.

What has become a 'trendy' tool of late to assess active management, is Active Share. Research has shown that the funds that are significantly outperforming their indices and peers, often have a high Active Share, and that it is an accurate measure in predicting future performance. So should it be your new go-to fund comparator?

Firstly, let's look at how it works. Active Share is a percentage figure, from 0-100, and the closer the number is to 100, the more stocks the fund manager's choices differ from the benchmark. Conversely, the closer the percentage is to 0, the more stock holdings they hold that match the benchmark. For example, if Vodafone made up 5% of the benchmark, and a fund didn't hold it, the fund would immediately have 5% Active Share, whereas if the fund held 5% in a small stock, not in the benchmark, it would also gain a 5% Active Share score. It is a useful measure to show how a fund overlaps with its benchmark and how a fund uses active management to differentiate from it.

Two examples of funds on the Chelsea Selection, which have recently added Active Share to their fund factsheets, are Neptune UK Mid Cap which has an Active Share of 94.3%, and Baillie Gifford, whose Japanese fund has an Active Share of 81%. With both of these funds generating 42.77% and 9.14% returns in the past two years* compared to 17.29% and 7.27% for their respective benchmarks, it adds weight to the correlation between a high Active Share and good performance.

On the other side, Active Share also highlights what are known as 'closet trackers'. These are funds claiming to be actively managed, which charge the higher fees associated with active management, but in truth behave like passive managers and just match, or track, their benchmark. It shows up funds that are charging excess fees for doing little work.  If you are paying for active management, you want to make sure your manager is active. Any Active Share score below 60% for an active manager is one sign of being a closet tracker and, if an Active Share score is low but the fees are high, it will be very hard for a fund to outperform it's benchmark.

However, active management has more facets to just picking and holding a stock; there are various other tactics that managers use that could adversely affect the Active Share score. One of these is where a manager will have temporary preferences to certain areas of the market, and could therefore move between overlapping the benchmark or not. For example, the manager may believe that smaller, high-growth stocks will be in favour, which are unlikely to be on the benchmark, and therefore the Active Share will be high. Conversely, he may be less optimistic about the market, and move his portfolio into larger, less risky companies, which are likely to be on the benchmark and therefore, the Active Share score falls.

With all that in mind, Active Share is clearly a useful tool in comparing funds. While funds that are generally successful usually have a high Active Share score, having a high score is by no means a guarantee of success, just that a manager is differentiating themselves, and trying to outperform a benchmark, which they equally could underperform. We use it as a starting point when researching a fund, not the end point, and use a variety of other factors too, to decide whether or not to add a fund to the Chelsea Selection.

By Ryan Lightfoot-Brown, research analyst, Chelsea


*figures correct as at 13/07/2015

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Ryan's views are his own and do not constitute financial advice.
Published on 15/07/2015