Active Share
Active Share measures the percentage of fund holdings that is different from the benchmark holdings. It was introduced in the paper "How Active is your Fund Manager", by Martijn Cremers and Antti Petajisto, published in the Review of Financial Studies in 2009, available for free on SSRN.
If a fund has an Active Share of 60%, then 40% of the holdings of the fund are identical to the holdings of the benchmark, and 60% of the holdings are different (constituting either over-weights or under-weights relative to the holdings of the benchmark).
Active Share is not a measure of skill but rather measures how different the fund's holdings are relative to the holdings of the particular benchmark considered. Any difference in performance can only come from fund positions that are different from the benchmark positions, i.e., that are 'active', and for any given fund, higher Active Share could lead to either underperformance or outperformance.
Active Share Calculation
Active Share can most easily be calculated as 100% minus the sum of the overlapping portfolio weights.
Here are some examples to illustrate how Active Share works for equity funds. First, any fund position in a stock that is not included in the benchmark results in no overlap with the benchmark and thus contributes to a higher Active Share. Second, for fund positions in stocks that are included in the benchmark, let's assume that a particular stock has a 2% weight in the benchmark.
- If the fund also has a 2% weight in that stock, then its holding in the stock completely overlaps with the weight of that fund in the benchmark. As a result, the fund has no active (or different) weight in the stock, and thus this position contribute to a lower Active Share.
- If the fund has a 3% weight in that stock, then the fund has a 1% overweight together with a 2% overlap. The 1% overweight will contribute to a higher Active Share and the 2% overlap to a lower Active Share.
- If the fund does not own that stock at all, i.e., has a zero weight in that stock, then the fund has a 2% underweight in that stock relative to the benchmark, which contributes to a higher Active Share.
Recent research using Active Share:
1. "The Complex Materiality of ESG Ratings: Evidence from Actively Managed ESG Funds", 2023, working paper (with Tim Riley and Rafael Zambrana)
- We introduce Active ESG Share as a novel metric of the extent of a fund manager’s use of ESG information. Active ESG Share compares the full distribution of a portfolio’s stock-level ESG ratings to that of its benchmark, capturing how actively a manager uses ESG information, rather than whether the manager tends to favor stocks with high or low ESG ratings. We find a positive relation between Active ESG Share and the future performance of actively managed mutual funds, but only among ESG funds, which we attribute to the importance of specialization. The results are strongest for ESG funds that tend to hold stocks with a high level of ESG ratings disagreement or uncertainty, consistent with such disagreement and uncertainty creating opportunity for active managers. Our results suggest that ESG information is financially material, but complex, and thus cannot be successfully capitalized on using simple directional strategies.
2. "Factor Investing Funds: Replicability of Academic Factors and After-Cost Performance", 2023, working paper (with Yuekun Liu and Tim Riley)
- Do factor investing funds successfully capture the premiums associated with academic factors? We explore this question using the growing number of factor investing funds that seek to capture those premiums. While, on average, such funds do not outperform, we find that the factor investing funds with the portfolios that most closely match their academic factors—determined using our novel, holding-based ‘active characteristic share’ measure—significantly outperform those that less closely match. Furthermore, adjusting for stock size, we conclude that the answer to our question is “yes” for closely matching factor investing funds, which net of costs duplicate the paper performance of the long side of academic factors.
3. "Why Have Actively Managed Bond Funds Remained Popular?", 2022, working paper (with Jaewon Choi and Tim Riley)
- In sharp contrast to equity funds, actively managed bond funds have remained popular. This paper explores why by examining how active share affects the performance, risk management, and flows of bond funds. We find that bond funds tend to be highly active and often invest outside of their primary asset classes. Bond funds with higher active share persistently earn higher alphas, demonstrate lower downside risk, and exhibit less flow sensitivity to poor performance (consistent with alleviating investor run risk). In conclusion, our results show that investors tend to benefit from active management in bond funds.
4. “Active Share and the Predictability of the Performance of Separate Accounts”, 2022, Financial Analysts Journal 78(1), 39-57 (with Jon Fulkerson and Tim Riley)
- Separate accounts are a large and unique, but understudied, part of the investment management industry. Within our sample, on net, the average separate account underperforms, but for those with high active share, we find positive performance persistence. Among high active share separate accounts, a portfolio of those with strong past performance has a subsequent net alpha of 1.38% per year (t-stat = 2.11). That result strengthens when return dispersion is high and among separate accounts with a small cap style, a fundamental investment approach, or lower cash holdings. These results provide out of sample support for the predictive utility of active share.
5. "Benchmark Discrepancies and Mutual Fund Performance Evaluation”, 2022, Journal of Financial and Quantitative Analysis 57(2), 543-571 (with Jon Fulkerson and Tim Riley)
- We introduce a new holdings-based procedure to identify whether a mutual fund has a benchmark discrepancy, which we define as a benchmark other than the prospectus benchmark best matching a fund’s investment strategy. We find that funds with a benchmark discrepancy tend to be riskier than their prospectus benchmarks indicate. As a result, the funds on average outperform their prospectus benchmarks—before further risk-adjusting—despite underperforming the benchmarks that best match their portfolios.
6. “Challenging the Conventional Wisdom on Active Management: A Review of the Past 20 Years of Academic Literature on Actively Managed Mutual Funds”, 2019, Financial Analysts Journal 75:4, 8-35 (with John Fulkerson and Timothy Riley)
- Just over 20 years have passed since the publication of Carhart’s landmark 1997 study on mutual funds. Its conclusion—that the data did “not support the existence of skilled or informed mutual fund portfolio managers”—was the capstone of an academic literature beginning with Jensen (1968) that formed the ‘conventional wisdom’ that active management does not create value for investors. In this paper, we review the literature on active mutual fund management since the publication of Carhart (1997) to assess the extent to which current research still supports the conventional wisdom. Our review of the most recent literature suggests that the conventional wisdom is too negative on the value of active management.
7. “Active Share and the Three Pillars of Active Management: Skill, Conviction and Opportunity”, 2017, Financial Analysts Journal 73(2), 61-79
- We introduce a new formula for Active Share that emphasizes that a fund’s Active Share is only reduced through overlapping holdings with its benchmark. Next, we relate Active Share to the fund manager’s individual stock picking skill, conviction and opportunity. We show why and how to adjust the expense ratio for the level of Active Share and the cost of investing in the benchmark. We conclude that Active Share matters for actively managed funds: investors should not pay (too) much for low Active Share funds which generally underperform, there is no evidence that high Active Share funds as a group have underperformed, while patient managers with high Active Share have been quite successful.
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