What is Active Share?
by James B. Tharin, CFA
There is a relatively new investment industry buzzword that you might want to learn before your next cocktail party or investment club meeting. The term ‘Active Share’ is still unfamiliar enough to most lay people that if you can work it into a conversation you might be able impress a few friends with your command of modern investment jargon. Active Share is a statistic that measures the difference between a portfolio’s holdings and the portfolio manager’s stated benchmark. According to Investopedia, “The researchers conclude that managers with high Active Share outperform their benchmark indexes and that Active Share significantly predicts fund performance.” Active Share is measured on a scale between 0 and 100. The implication is that we want to choose investment managers with a high Active Share.
Simple logic should point to the notion that in order to beat a benchmark, then an investor or portfolio manager must deviate from that benchmark in some way. Managers who attempt to minimize deviations in performance from their stated benchmark often do so because of career risk as opposed to an attempting to maximize performance. According to the article “The Career Paths of Mutual Fund Managers: The Role of Merit (Porter and Trifts) which appeared in the July / August 2014 edition of the Financial Analyst Journal, mutual fund managers who underperform their peer group are more likely to lose their jobs. Since the penalty for underperformance seems to be greater than the reward for outperformance, many portfolio managers tend to be ‘closet indexers’. Said differently, these firms charge the higher fees justified by successful active management but their portfolios look and act like index funds. The high fees these managers charge tend to lead to underperformance relative to the benchmark or a suitable alternative index fund. Closet Indexers can easily be spotted by their low Active Share.
In order to separate the Emerald Asset Management Global Stock Portfolio from the pack and avoid the phenomenon described above, we measure the Active Share of the Global Stock Strategy and strive to keep it high. It is important however to draw a distinction between high Active Share and benchmark misspecification. Selecting an appropriate benchmark is critical when making statistical or qualitative analysis of a portfolio.
There are three ways to increase Active Share. The first way is through tactical asset allocation. The second way is by purchasing securities that are not part of the stated benchmark. The third way to achieve a high Active Share is to own the securities that are part of the benchmark but with a different weighting scheme than that of the benchmark. At Emerald Asset Management we use all three of these techniques.