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.


  • ljoneill says:


    Active share has been gaining in popularity for the last few years, at least in academia and in a few corners of the fund/asset mgmt world. You are clearly right that most institutional investors aren’t jumping in with two feet. Why? I likely won’t tell you anything you don’t already know, but the reasons are many:

    1. For a plan sponsor, it’s not all about alpha. It’s about risk management at the total fund level and having a level of predictability about how their overall plan will do compared to the markets. That makes planning (benefits levels, new funding commitments, etc.) much easier. If you had a portfolio of only a few highly active managers, that planning process becomes much more difficult. It’s a nature of that beast.

    2. Because of the above, plans are more than happy to get a very modest level of alpha vs. their benchmark. In the institutional world, fees are much much lower, and so it’s therefore easier to beat the benchmark net of fees. Enhanced indexing gets a ton of flow because some managers have shown an ability to consistently generate 50-100bps of alpha net of fees. That’s immensely more difficult in the mutual fund world, but it’s doable in institutional separate account land. And that’s fine with pensions to get 75bps higher than the SP500 with a higher level of predictability. Do they lose some potential alpha? Sure. Do they gain a sleep at night quality? Sometimes!

    3. In some sense, active stock pickers should be thrilled with all the money flowing to closet indexers. That’s what creates a lot of mispricing in the market. If every multi-billion dollar fund was super active, well…we’d live in a very different investing world!

    So, with that said, I think there is some potential middle ground for your new venture. We can chat more about it off-line, but lots of consultants and plan sponsors like concentrated managers as long as there is some level of benchmark-relative risk management that occurs. Your approach of equal weighting makes some intuitive sense, but I wonder if it would be worthwhile to start a separate composite where you were more cognizant of correlations and did some sort of quasi-optimization to keep tracking error vs. the benchmark at a reasonable level (in a consultant’s eyes). Do you give up some alpha? Perhaps a bit, but not much I don’t think. And you could gain access to a whole new set of potential prospects.

    By the way, another link of active share:

    • If everyone chased active share, things would be nuts.

      And yes, I’ve been in the business of hugging the index, when I marketed pension products to small plans. Stay out of the fourth quartile, and assets are sticky.

      As for growth, yes, I plan on adapting my weighting scheme to one that reflects weighted float when it gets large enough to matter. In the short run, I may create an odd lot bucket for very illiquid names that are attractive to sit on. It would not count against positions, or it might be one position in aggregate.

      Though, all that said, if everything a plan sponsor were relying on was aimed at stability of funding, they would invest only in high quality bonds. They are relying on the equity premium to do a lot of heavy lifting, which is one reason that it is not working now.

  • Doug says:

    Active Share is a nice idea. But I’ve yet to see rigorous studies that show that it can add value consistently over time. I’m not a closet indexer, but a lot of underperformance comes from what you don’t own rather than what you own. “Batting for singles” is a legitimate strategy, especially when you’re looking at risk-adjusted return.

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