Finding alpha-driven fund managers can be made easier by combining the active share measurement with a stockpicker’s average holding period, according to new research.
Active share pioneer Martijn Cremers, a professor at the University of Notre Dame, said his study showed that fund managers with a high active share and long holding periods significantly outperformed markets over the past 26 years.
The research looked at US data and ranked investment funds in active share quintiles, showing the highest quintile – funds with active shares of between 80 and 100 per cent – outperformed by the most in the long term.
Mr Cremers said the same trend was even observed after removing the 2000 dotcom bubble, where active managers significantly outperformed a falling index.
He said: “In the highest active share quintile, almost all of the outperformance historically has come from the patient high active share managers. The outperformance is so large we have become very confident about these results.
“Statistically, we can confirm these managers as a group have outperformed.”
Presenting findings at the Morningstar Conference in London last week, Mr Cremers said investors had to be wary of using either active share or holding period metrics in isolation, as both had the potential to provide misguided signals of a manager’s ability.
He said the reasons for combining the two factors made sense, given a high active share did not necessarily prove any aspect of stockpicking skill or conviction.
He accepted those without skill or conviction were unlikely to have high active shares, but said some may still skew results.
“Active managers who are successful in the long term need to have skill, but also conviction to apply the identified investment opportunities consistently,” he said.
“[Active share] is not a measure of skill. You do not need skill to have high active share, you just need to buy a bunch of different stocks [to the index].”
Mr Cremers noted that low-turnover strategies could also be found among passives and closet trackers: 50 per cent of assets in the top quintile of low-turnover funds also fall into the lowest quintile for active share.
“Closet trackers or index funds tend to be patient, which is why it is so important to not just look at patience, but view it in conjunction with active share. It is a combination of the two,” he said.
Mr Cremers’ work, which has just been published in the Journal of Financial Economics, also looked at the correlation between active share and outperformance. He said the results showed funds in the lowest quintile of active share underperformed, while the top quintile outperformed.
However, the professor added a caveat: “Statistically, we are very confident about the underperformance of the lowest active share funds. [But] we’re not very confident about the outperformance of the highest active share funds.
“This is because low active share will have returns similar to the benchmark. With high active share funds there is a lot more dispersion in performance and it is a lot more volatile.”
Outperformance was somewhat easier to find when combining the metric with funds investing in a specific part of the capitalisation scale.
Looking purely at active share, large-cap funds in the lowest quintile either matched or underperformed their benchmarks. For those in the higher quintiles, Mr Cremers said it was not statistically possible to make a link between outperformance and high active shares for large-cap offerings.
“The results look better for small-cap managers. All active share quintiles outperformed, particularly the higher active share,” he added.
Key numbers
49%: Proportion of assets in top duration quintile also in lowest active share quintile
10%: Proportion of assets in top active share quintile
