Active Management Under The Microscope

So-called “active share” metrics may point to the extent, and cost, of active management in a fund, but other measures can sometimes give more transparent details.

Just how actively managed is your actively managed mutual fund? And, more importantly, what’s the real pay-off for all that activity?

These long-standing questions took center stage with the recent publication of research on the so-called “active share” metric. Simply put, active share represents the percentage of a portfolio that varies from a fund’s benchmark index. It’s derived by comparing the fund’s security weightings to those of a benchmark. Prior to the mathematical quantification of active share, the extent and the cost of active management had to be inferred from a fund’s performance.

Equity funds can be thought of as two portfolios in one wrapper. The first, a “passive” component that holds the benchmark securities, much like an index fund, and the second, the “active” part that’s made up of securities held in weights that differ from the benchmark’s, or even outside of it. The passive segment provides beta, or market exposure, while the active element is the alpha engine which aims for outperformance.

Active share is advertised as a gauge of the appropriateness, or “fit,” of various benchmarks as well as a measure of consistency in a fund’s investment strategy. Early studies seemed to indicate that funds with high active share values outperformed portfolios with low values, though follow-on research has thrown doubt on that notion.

There are inherent problems with the active share construct. First of all, you need to monitor the fund’s and the benchmark’s portfolio in real time in order to assess consistency, a feat not easily accomplished by retail investors or their brokers. Additionally, stock-by-stock analysis is required, a laborious procedure when the benchmark holds hundreds or thousands of issues.

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DisclosureBrad Zigler pens's Alternative Insights newsletter. Formerly, he headed up marketing and research for the Pacific Exchange's (now NYSE Arca) ...

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