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Academic Research

These academic papers, co-authored by Martijn Cremers, provide further background and explanation on Active Share:

• "How active is your fund manager? A new measure that predicts performance" (with Antti Petajisto), Review of Financial Studies, 22, 2009
  • We introduce a new measure of active portfolio management, Active Share, which represents the share of portfolio holdings that differ from the benchmark index holdings. We compute Active Share for domestic equity mutual funds from 1980 to 2003. We relate Active Share to fund characteristics such as size, expenses, and turnover in the cross-section, and we also examine its evolution over time. Active Share predicts fund performance: funds with the highest Active Share significantly outperform their benchmarks, both before and after expenses, and they exhibit strong performance persistence. Non-index funds with the lowest Active Share underperform their benchmarks.
• "Indexing and Active Fund Management: International Evidence" (with Miguel Ferreira, Pedro Matos, and Laura Starks), Journal of Financial Economics, 2016
  • We examine the relation between indexing and active management in the mutual fund industry worldwide. Explicit indexing and closet indexing by active funds are associated with countries’ regulatory and financial market environments. We find that actively managed funds are more active and charge lower fees when they face more competitive pressure from low-cost explicitly indexed funds. A quasi-natural experiment using the exogenous variation in indexed funds generated by the passage of pension laws supports a causal interpretation of the results. Moreover, the average alpha generated by active management is higher in countries with more explicit indexing and lower in countries with more closet indexing. Overall, our evidence suggests that explicit indexing improves competition in the mutual fund industry.
• "Patient Capital Outperformance: The Investment Skill of High Active Share Managers Who Trade Infrequently" (with Ankur Pareek), Journal of Financial Economics, 2016
  • Among high Active Share portfolios – whose holdings differ substantially from their benchmark – only those with patient investment strategies (with holding durations of over 2 years) on average outperform, over 2% per year. Funds trading frequently generally underperform, including those with high Active Share. Among patient funds, separating closet index from high Active Share funds matters, as low Active Share funds on average underperform even with patient strategies. Our results suggest that U.S. equity markets provide opportunities for longer-term active managers, perhaps because of the limited arbitrage capital devoted to patient and active investment strategies.
• "How Active Is Your Real Estate Fund Manager?" (with Colin Lizieri), Journal of Alternative Investments, Summer, 1-15, 2015
  • Using a holdings-based measure of active management termed the ‘Segment Active Share,’ the paper documents that commercial real estate portfolios that are more active – i.e., have segment weights which are least like those of the index – have outperformed. Employing proprietary IPD data for 256 U.K. real estate funds over 2002-2011, we find that funds with high Segment Active Share on average outperformed the real estate market by 1.9% per year. These funds do not seem to take increased risk and their outperformance cannot be explained by fund size alone, though on average they are smaller funds.
• “Do Mutual Fund Investors Get What They Pay For? The Legal Consequences of Closet Index Funds” (with Quinn Curtis), Virginia Law & Business Review, 2016
  • Actively managed mutual funds sell the potential to beat the market by picking stocks that are expected to outperform passive benchmarks like the S&P 500. Funds that are marketed as active vary substantially in the degree to which their portfolio holdings actually differ from the holdings of passive index funds. A purportedly active fund with a portfolio that substantially overlaps with the market is known as a closet index fund. Since closet index funds charge considerably higher fees than true index funds but provide a substantially similar portfolio, they tend to be poor investment choices. This article presents empirical evidence on closet index funds, showing that more than 10% of U.S. mutual fund assets are currently invested in closet index funds and that high cost closet index funds substantially underperform their benchmarks. We argue that persistent closet indexing implicates a number of legal issues, including possible liability for fund advisors under the Securities Act and the Investment Company Act. We conclude by discussing potential adjustments to mutual fund disclosures that could help investors identify closet index funds.
• "Active Share and the Three Pillars of Active Management: Skill, Conviction and Opportunity", Financial Analysts Journal, 2017
  • 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 fund performance: investors should not pay (too) much for low Active Share funds, while among high Active Share funds only patient managers with long-term convictions have been successful.
• “Challenging the Conventional Wisdom on Active Management: A Review of the Past 20 Years of Academic Literature on Actively Managed Mutual Funds”, (with John Fulkerson and Timothy Riley), Financial Analysts Journal, 2019
  • 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.
• "Benchmark Discrepancies and Mutual Fund Performance Evaluation”, (with Jon Fulkerson and Tim Riley), Journal of Financial and Quantitative Analysis, 2022
  • 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.
• Active Share and the Predictability of the Performance of Separate Accounts”, (with Jon Fulkerson and Tim Riley), Financial Analysts Journal 78(1), 2022
  • 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.
• "The Complex Materiality of ESG Ratings: Evidence from Actively Managed ESG Funds", (with Tim Riley and Rafael Zambrana),  working paper, 2023
  • 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.
• "Factor Investing Funds: Replicability of Academic Factors and After-Cost Performance", (with Yuekun Liu and Tim Riley), working paper, 2023
  • 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.
• "Why Have Actively Managed Bond Funds Remained Popular?", (with Jaewon Choi and Tim Riley), working paper, 2022
  • 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.