8th March 2015 by The Value Perspective
By Kevin Murphy
Active share – the hitherto little-known academic measure of the extent to which the weightings of a fund’s holdings differ from those of its benchmark index – has been enjoying a more heightened media profile in recent weeks. The general tone of the coverage has been that a higher active share is A Good Thing and fund groups have consequently been queuing up to flaunt their percentages to the world.
Long-time visitors to this site may recall that we first considered active share back in 2012,when we offered a qualified endorsement of the idea – ‘qualified’, as we will shortly see, being the operative word. More recently, in Active service, we highlighted a paper that suggested a high active share combined with a longer-term outlook can contribute to strong investment performance.
However, contrarians that we are here on The Value Perspective, this sudden interest in active share has made us uneasy – and particularly the implications bubbling through in some quarters of the press that picking a portfolio with a high active-share number is some kind of short cut to, or even guarantee of, investment success.
Among the more balanced recent articles we have read on the subject was one that appeared in the Financial Times under the headline, Active share revealed to have feet of clay, and observed: “Although high active share managers undoubtedly have more scope to beat the index than closet trackers do, they also have more rope to hang themselves with poor decisions.”
This was precisely the point of that caveat we imposed back in 2012 – that a high active share will only be of any real benefit to investors if it is allied to the skills of a good stock-picking manager. Clearly anyone could create a very high active share from a portfolio of imaginatively random companies but that hardly guarantee clients will be queuing up to thank them five or 10 years down the line.
That may seem blindingly obvious but apparently it still needs saying. We do also have more nuanced arguments as to why investors should not automatically choose a higher active-share number over a lower one – not least that any funds benchmarked against concentrated domestic indices are just much more likely to have a lower active share than more globally-oriented portfolios.
A more interesting point still, certainly from a value perspective, is that those now advocating the attractions of a high active share appear to be overlooking the fact there will be times in a market cycle when the very largest businesses in a concentrated benchmark index will be very attractively valued – and we do not need to look very far afield for a plausible illustration.
Miners still make up a significant proportion of the FTSE All-Share index and, while we are hardly persuaded by the investment case for them at present, we are keenly aware that circumstances can and do change. Were we at that point to sell some mid-cap stocks to buy into the sector, we would be lowering our active share – but for perfectly valid and logical investment reasons.
Choosing to do otherwise simply to preserve a higher active-share number would be perverse – as it were, allowing the tail to wag the dog – and offers a warning against focusing too much on a single number or metric. No matter what the media might suggest or how much investors may dream, there is no short cut to selecting funds and their managers – and no more robust way of doing so than focusing on their investment process over the course of an entire market cycle.