Evaluating active managers and Active Share - Good Returns (2023)

FAQs

What is a good Active Share number? ›

The authors established that an Active Share of 60% or higher is generally considered active management. An Active Share of 20% to 60% is considered closet indexing, and an Active Share of less than 20% is considered passive (Exhibit 2).

Research by Morningstar found that about 40% of nearly 3,000 active funds outperformed their average passive peer over the 12 months through June. That success rate is worse than the 47% recorded in all of 2021, when markets were far less volatile.

Active managers shine most in large-cap investments outside of the United States, according to Investment Metrics. Not all active managers struggle to beat market returns.

Active Share is a measure of the percentage of stock holdings in a manager's portfolio that differs from the benchmark index. Managers with high Active Share have been found to outperform their benchmark indexes. The conclusion drawn by the study is that Active Share significantly predicts fund performance.

For a strategy that does not short stocks and does not purchase stock on margin, active share will always be between 0% and 100%. In contrast, the active share of a hedge fund strategy can exceed 100% due to its use of leverage and short positions.

Active share is a measure of the difference between a portfolio and a benchmark. It's an important concept for investors wishing to judge how fund managers' portfolios deviate from the index, and how that affects performance.

Ganti said underperformance rates remain high because active managers historically have had higher costs than passive managers. Because stocks are not normally distributed, active portfolios are often hindered by the dominant winners in equity markets.

What it means for investors. From an investor's perspective, it matters little whether managers are skilled or not, because fees eat up much of whatever skill and market-beating ability exists. Before costs and fees, active managers on average beat their benchmarks by 5 bp.

According to a 2020 report, over a 15-year period, nearly 90% of actively managed investment funds failed to beat the market. Portfolio managers are often Ivy League-educated investors who spend their entire workday attempting to outperform the stock market.

Active share is a measure of the difference between a portfolio's holdings and those of its benchmark, and the industry has increasingly used it as a proxy for how “actively” an investment manager is managing a portfolio.

Why should we care about Active Share? ›

Active share is a measure of how much a fund's holdings deviate from its benchmark index, and funds with the highest active share tend to have the best relative performance (in order to outperform, you must deviate from the benchmark).

Active share is calculated by totaling the absolute value of the differences between the weight of each position in the portfolio and the weight of each holding in the benchmark and dividing by two.

In general, actively managed funds have failed to survive and beat their benchmarks, especially over longer time horizons. Only one out of every four active funds topped the average of their passive rivals over the 10-year period ended June 2022.

With no human portfolio manager to pay, costs are much lower than active management. While fees can affect returns, there's more to successful investing than cutting costs. Despite higher fees, active managers have the potential to add value to investor portfolios.

“Active” Advantages

Among the benefits they see: Flexibility – because active managers, unlike passive ones, are not required to hold specific stocks or bonds. Hedging – the ability to use short sales, put options, and other strategies to insure against losses.

For example, if the benchmark return is 5% and the actual return is 8%, the active return would then be 3% (8% - 5% = 3%). If the same portfolio returned only 4%, it would have a negative active return of -1% (4% - 5% = -1%).

Theoretically, an index fund should have a tracking error of zero relative to its benchmark. Enhanced index funds typically have tracking errors in the 1%-2% range. Most traditional active managers have tracking errors around 4%-7%.

Generally speaking, many portfolio managers would view a “good” IC as 0.05 and a “very good” IC as 0.10.

Active share measures how much an equity portfolio's holdings differ from the benchmark index constituents. In recent years, the investment community has embraced this concept both as a gauge of active management inherent in an investment portfolio and, increasingly, as an indica- tor of potential future excess return.

Understanding Benchmarks. Market benchmarks are indexes created to include multiple securities, assets, or other instruments to represent the performance of a stock, fund, or any other investment of the same type and composition. Benchmark indexes have been created across all types of asset classes.

What is a smart beta strategy? ›

Understanding "smart beta"

Smart beta refers to an enhanced indexing strategy that seeks to exploit certain performance factors in an attempt to outperform a benchmark index. In this sense, smart beta differs fundamentally from a traditional passive indexing strategy.

If you own an investment fund that's “actively managed,” odds are that your returns lagged in 2021. Those chances are even worse over a multiyear time frame. Mutual and exchange-traded funds are generally “actively” or “passively” managed. In the former, a fund manager selects the fund's stocks and bonds.

Index funds seek market-average returns, while active mutual funds try to outperform the market. Active mutual funds typically have higher fees than index funds. Index fund performance is relatively predictable over time; active mutual fund performance tends to be much less predictable.

High-yield active managers also did well last year, with about 70 percent of them outperforming their Bloomberg Barclays benchmark. It was a rare win for high-yield managers: Over the last ten years, only 13 percent of active managers targeting U.S. high-yield did better than the index — again, before fees.

Mutual fund fees are expressed as a percentage, or expense ratio, of your overall investment. They typically range from . 5% to 1.5% for actively managed funds, and . 2% for passively managed funds.

In any given year, most actively managed funds do not beat the market. In fact, studies show that very few actively managed funds provide stronger-than-benchmark returns over long periods of time, including those with impressive short term performance records.

Actively managed portfolios can offer greater flexibility to protect wealth throughout a market cycle, particularly during market downturns. The more passive the strategy, the more an investor is unnecessarily exposed to performance-crushing returns during a decline.

Across nine U.S. style categories, large-cap value managers performed the best over the 10-year horizon, with 32% of managers outperforming the benchmark, the S&P 500 Value.

While the C-Fund invests in companies that are included in the S&P 500, the S-fund includes smaller companies than those that would be found in the C-fund. The “S” in S-fund stands for “small company stocks” but includes companies with market capitalizations that are considered medium-sized and large.

The Difficulty Of Investing In The Stock Market

There are 3 barriers that prevent an individual from investing in the stock market: fear, inequitable access, and insufficient funds.

What does Active Share indicate? ›

Active share is a measure of the difference between a portfolio's holdings and those of its benchmark, and the industry has increasingly used it as a proxy for how “actively” an investment manager is managing a portfolio.

Active share is a measure of the differentiation of the holdings of a portfolio from the holdings of its appropriate passive benchmark index.

Theoretically, an index fund should have a tracking error of zero relative to its benchmark. Enhanced index funds typically have tracking errors in the 1%-2% range. Most traditional active managers have tracking errors around 4%-7%.

The term most active refers to stocks whose shares have the highest trading volume on a stock exchange over a given period of time.

Active share is calculated by totaling the absolute value of the differences between the weight of each position in the portfolio and the weight of each holding in the benchmark and dividing by two.

For example, if the benchmark return is 5% and the actual return is 8%, the active return would then be 3% (8% - 5% = 3%). If the same portfolio returned only 4%, it would have a negative active return of -1% (4% - 5% = -1%).

Generally speaking, many portfolio managers would view a “good” IC as 0.05 and a “very good” IC as 0.10.

Understanding Benchmarks. Market benchmarks are indexes created to include multiple securities, assets, or other instruments to represent the performance of a stock, fund, or any other investment of the same type and composition. Benchmark indexes have been created across all types of asset classes.

All other security types such as cash, bond, warrants and derivatives are excluded.

Active risk (tracking error) is a function of the portfolio's exposure to systematic risks and the level of idiosyncratic, security-specific risk. It is a relevant risk measure for benchmark-relative portfolios. Absolute risk is the total volatility of portfolio returns independent of a benchmark.

What is a good Sharpe ratio? ›

Generally speaking, a Sharpe ratio between 1 and 2 is considered good. A ratio between 2 and 3 is very good, and any result higher than 3 is excellent.

Given a sequence of returns for an investment or portfolio and its benchmark, tracking error is calculated as follows: Tracking Error = Standard Deviation of (P - B) Where P is portfolio return and B is benchmark return.

1 Active return equals the difference in return between a portfolio and its benchmark. Tracking error, as active risk is more commonly called, measures the volatility of active returns. Both tracking error and absolute volatility are measured in units of standard deviation.

The “volume” number is the total number of shares traded in that stock in one day. The “value” number is the total amount of money spent to buy all of the shares that were traded. “Volume turnover” expresses the day's volume relative to the total outstanding shares of the stock.