Active Share

I often have to deal with practical “small institution” problems, because of the church I belong to.  Here are two of them:

1) The pastors have a defined contribution plan.  There are two questions.  Are the funds the best that we can get?  Are the asset allocation options that draw from those funds properly calculated? (Two-thirds of the pastors use those.)

For the first question, we have a board member who works for a major fund consultant.  He will easily be able to answer the question.  As for the second question, I have analyzed how the offered funds have done over the last 20 years.  Those allocations have done well in the past.  The problem is, when did the consultant do the look backwards and set the percentages?

The tendency is that once the percentages are set, future performance tends to decline.  Select managers who have done better than they normally would, and watch them regress to the mean, or worse.

My view is select managers that have done well for reasons that are not common to the environment that they were in.  There are often trends that benefit certain managers, then once the trend goes, they are gone as well.  But who did well in spite of the trend?  Those are managers to look at.

2) Recently, four members of my congregation came to me and said, “Here’s the list of managers in my401(k), who should I invest with?”  and “Here’s the portfolio my husband left me (after death), what should I do?  I can never turn down a friend, and particularly not a widow.

This was interesting.  As I looked into the mutual funds, I relied less and less on the performance statistics, and Morningstar stars, but looked at the actual portfolios in concert with performance, and decided that those with unusual portfolios with reasonably good performance were better choices.  Why?  They aren’t following the market.

Today, I ran into a name for that concept: Active Share.  How much does a manager vary from the index?  If you’re going to be an active manager, you ought to vary from the index quite a bit.  That is what you should be paid to do.

“But wait,” says the fund marketer, “Beating the index is the best, but missing the index is the worst.  We survive best with performance that is out of the fourth quartile.  So hug the index as you make modest bets against the index.”

Those are the portfolios I want to avoid.  An article in the WSJ concurs.  Don’t pay active fees for index-like performance.

I feel that way about my own investing.  If I am not looking at stocks that are less considered than most, then what am I getting paid for?  I would rather fail unconventionally than succeed conventionally.

And yet I know that managers that have high active shares, though they may do well on average, get excluded by fund management consultants, because they are too unpredictable.

Look, I am trying to make money for clients.  Consultants are a necessary evil in that process.   Clients would be better off without consultants, but that will never happen, because clients want to stay out of the fourth quartile.

My active share is large, and I have done well.  Does that mean that a lot of people will invest with me?  Probably not, because they are not willing to endure an odd portfolio that isn’t mainstream.  Well, that is their loss.