Making the active share of funds accessible on factsheets would be misleading for potential investors, according to JP Morgan’s Piera-Elisa Grassi. 
The executive director of the JPM Global Research Enhanced Index fund says that, while active share signals the conviction levels of a fund manager, it doesn’t provide an indication of their level of skill and should not be relied upon to gauge the quality of a fund.
The active versus passive debate has become increasingly heated since the introduction of RDR in 2013, which has since pushed transparency and fairness to the forefront of investors’ minds. It has been further intensified by the increased attention on ‘closet trackers’, which charge active fees while still hugging their benchmarks.
Over recent months, active share – which measures the likeness of a fund’s holdings to its underlying benchmark – has been touted as a potential solution to identify truly active managers.
While a lot of retailers seek high levels of active share in an investment vehicle and are perturbed if it is unavailable on a factsheet, Grassi argues that it should not make a significant difference when making a decision and could actually misrepresent a manager’s performance.
“I actually think that if you put [active share] on a factsheet it could be misleading for the investor,” she said.
“Active share can easily become a tool in the toolbox for investors. What we’ve seen over the last few years is an intensified focus on active share from journalists and also the regulators who have been very vocal about it across Europe.”
“Whether it’s the institutional investor or the retail investor, everybody has been looking at it and debating. I guess the key question that we have had around the topic has been: is your fund manager active enough?”
While Grassi believes this question is valid, she says that the answer doesn’t simply lie in the active share number and that it is just one small factor that has been given more importance by the media than it should have.
Active share is calculated by taking the difference in weightings between the portfolio and its benchmark, then dividing that figure by two.
The simplicity of this equation, which is based on data from just two variables, means that the figure is nowhere near enough to determine the efficiency of a fund according to Grassi, as all it does is measure the percentage of the investment vehicle’s stocks that aren’t in its benchmark.
“As a measure itself, it’s quite crude and quite simple. While in its simplicity you can get an immediate number, there is a lot of other variable information that you’re missing while you’re looking at this data,” the executive director continued.
“Yes, you’re getting an idea of what the difference is in the benchmark, but there are things you’re missing here. If you think about it in a portfolio, active share can range from zero to 100. Zero is easy to understand – if the active share is zero, it’s passive. If it’s 100, it’s fully active and completely away from the benchmark.”
“But what happens in between? If you look at two portfolios and the active shares are both 60, does it really mean that they are equal? Probably not. If they’re benchmarked against two different indices and the concentrations of the indices are different, 60 can mean very different things.”
Other factors that alter the meaning of an active share number include whether the fund has a size bias, whether its index concentrations are the same and whether there are assets in the portfolio that are outside of the index altogether.
As a result, Grassi believes that active share can be an unfair comparison tool when these factors aren’t accounted for.
For instance, two funds could both have the same high level of active share, yet they could have an entirely different tracking error and risk concentration from each other.
“Yes, active share gives you a sense of whether the fund manager is active or not, but does it tell you anything about their skills? Not really. It just tells you that they’re active managers that believe in something a lot, but that something is not really clear to you,” she pointed out.
“By just looking at that measure, you don’t get an idea of whether their stock selection is driving the performance, or potentially if their macro view is driving the performance. Simply put, that data is not coming out of that single number - it also doesn’t tell you the ability of the fund manager.”
In an article published earlier this week, in fact, FE Alpha Manager John Bennett warned that managers with a high active share could struggle to outperform throughout the remainder of 2015, due to a potential market rally over the next few months if oil and mining stocks (which most people are severely underweight) continue showing signs of mean reversion.
Performance of indices in 2015
Source: FE Analytics
Therefore, he pointed out that looking more like the benchmark may be the best way to outperform over the short term.
“I believe the index is set to make a bit of a comeback. It might only last a month or three months, but it could be a painful one against active managers,” he said.
“This is really quite interesting and, right now as we speak, so contrarian that you’d be marched right out of the room because you’re seen as mad to even consider it.”
This prediction is a prime example that straying away from the benchmark doesn’t correlate with strong returns, and Grassi says that there are various measures that should be used alongside the active share of a fund at the very least.
While past performance is no guarantee of future performance, the executive director says that historical measurements such as historic tracking error, excess returns, maximum drawdown and excess returns should be used in addition to active share, alongside ‘point in time’ measures such as geographical and sector deviations.
“Analysing historical behaviour can really help the investor to match up the philosophy that is proposed by the manager with the result they have actually delivered,” she explained.
“Active share is definitely one component but it needs to be put into context and a lot more measures need to be utilised when you look at the fund. I appreciate that in the institutional world we can do this more easily because we’re a lot more familiar with the statistics and we can probably access them more easily.”
“However, I think a lot of education needs to be done from the top-down to the middle man, because the individual investor might not be aware that just using active share to compare two or three funds could be irrelevant if they have different benchmarks or if they have different styles. It might not be enough of a measure to guide their investment decisions.”
