How active does a fund need to be?
The question we challenge ourselves on is how active does a fund need to be? Fidelity has conducted some extensive work on this subject and the conclusion of its findings is summarised in the chart right. The research suggests that higher levels of active share are correlated with positive excess returns.
You will note that at 60% active share and a 4% TE, the average excess return is negligible providing some validation to ESMA’s comments. However, funds with an active share of above 70% are increasingly likely to outperform.
We applied this analysis to our equity fund research list, which consists of 166 funds and £6bn of assets. The average active share of our funds is 81% and the average tracking error is 6.3%, comfortably above “closet tracker” territory. Expanding this analysis further, 83% of our funds and 88% of our assets lie within funds that have an active share of 70% and more, so we believe at a headline level our research list is well positioned according to Fidelity’s analysis and should this outperformance be achieved then paying an active fee is in fact justified.
Of the remaining 12% of our assets, 10% lies within the 60%-70% active share range, composed of funds that are either single country focused, special sector plays or UK income funds where it is difficult to have high active share given their finite investable universe. That said, they do still have the possibility of outperforming at these levels of active share, albeit at lower levels in accordance with Fidelity’s research. The remaining 2% below 60% active share lie in a partially active tracker and single country funds, so on reflection we are very comfortable with the exposure we have at these active share levels.
