Active share measures how different a portfolio is from the composition of its benchmark. In other words, it can be used to help investors differentiate between closet-tracker funds and the managers looking to add the most value for their clients.
A number of studies, including one recently highlighted by FE Trustnet, have shown that there is a positive correlation between higher active share and outperformance. Unsurprisingly, some of the best managers in any given IMA sector are often the ones with the highest active shares.
Brooke (pictured), who heads up the five-crown rated Trojan Income fund, is a big proponent of active management and thinks those that charge active fees for index performance should be brought to account. However, he says the growing emphasis on active share could have negative consequences.
“I think in some instances, active share can be a bit of a trap,” he said. “Two funds with the same high active share could give investors very different outcomes. It’s not a silver bullet.”
“There’s this idea that you need a high active share to be a good fund manager, but this is only one of a number of factors that should be considered: the beta and alpha of a fund, its absolute volatility, the types of companies it holds, and so on.”
“If you’re saying that you should only invest in active managers with a high active share – and it’s increasingly feeling that way – I think you are encouraging investors to take on a lot more risk. You’ve got to temper this with other factors, otherwise it’s a real danger.”
Brooke believes it’s a misconception to think that only funds with the highest active share have a chance of being the best performing.
A recent report by Numis argued that any fund with an active share of 50 per cent should be considered active, and one with over 70 per cent “most certainly active.”
Brooke’s Trojan Income fund has an active share of around 73 per cent according to the manager, which is by no means the highest in his IMA UK Equity Income sector.
According to FE data, the £2bn Trojan Income fund is the seventh best performing fund in the 89-strong IMA UK Equity Income sector over 10 years, with returns of 149.48 per cent. It’s also the least volatile fund of its kind over the period by some distance and has the lowest max drawdown.
Impressively, the fund has the joint highest Sharpe ratio at 0.95, sharing with Unicorn UK Income.
Risk/return of IMA UK Equity Income sector over 10yrs
Source: FE Analytics
As well as being a consistent top quartile performer, Trojan Income is also ahead of its FTSE All Share benchmark with less volatility over one, three, five and 10-year periods.
Brooke says his ability to protect investors against the downside but participate on the upside, by investing in defensive dividend-paying large and mid-cap companies, has allowed him to post significant outperformance without having an extremely high active share.
“It’s a fallacy to think that you have to take on more risk to generate more returns,” he said. “People think a fund couldn’t possibly outperform when it has a beta of less than one, but we’ve been able to outperform with significantly less volatility.”
Performance of fund, sector and index over 10yrs
Source: FE Analytics
The FTSE All Share has risen in eight of the last 10 calendar years, and is up year-to-date. Trojan Income has a beta of just 0.61 over the decade, yet is still almost 34 percentage points ahead of the index.
The fund’s stellar performance in 2008 – it lost just over 12 per cent compared to the All Share’s 29.93 per cent – has been a big driver of the outperformance overall.
At first glance, it’s difficult to see how Brooke has managed to outperform by such an extent. His top 10 is, and has historically been, packed full of companies that make up a big chunk of the index, such as GlaxoSmithKline, HSBC, BP and Shell. They all have more than a 3.5 per cent weighting at present.
However, avoiding large sectors such as the banks during the financial crisis has helped him add significant value, as has his meaningful overweights in some mid-cap companies. He currently holds the likes of Pennon and WH Smith in his top 20.
Brooke has also used cash tactically to his advantage, including in 2008 when he held up to 15 per cent.
As is almost custom, Brooke is cautious in his outlook for UK equities. While he attempts to keep up with his benchmark during rallying markets Brooke prioritises protecting investors from downside risk and at the same time maintaining and hopefully growing his dividend.
This, he says, makes him naturally more defensive than his peers.
“I think there’s around a 50 per cent chance of us having a similar year next year to this year. Looking at the remaining 50 per cent, I think the chances are that things will be worse than better,” he said.
“It’s hard to see how earnings and dividends are going to grow strongly from here, given the slowdowns that are occurring in the eurozone and China. It’s difficult to see where the catalysts for further gains are coming from.”
Brooke notes that the Bank of England’s tone surrounding interest rate rises has shifted, which again could be a risk to investors next year if there is indeed a change in policy.
“There’s been a change – the Bank is now saying the UK consumer could take a 2 per cent hike,” he said.
Trojan Income hasn’t cut its annual dividend payout since its launch in 2004, growing it every year with the exception of 2008, when it kept it at the same level. It is a member of the FE Select 100 and rated by the FE Research team as one of the standout options in the sector for equity investors who rely on a stable dividend stream.
The fund has ongoing charges of 1.03 per cent and is available on most major platforms.
