Genuine stock picking talent is something that is rightly celebrated – and generously remunerated – but I can’t help thinking that today’s obsession with active share is in danger of becoming nothing more than a marketing ploy. After all, what’s wrong with good old fashioned tracking error?
For Eoin Murray, head of investment office at Hermes Investment Management, active share is “much talked about, often misunderstood and occasionally misused”.
He sees it as very much a point-in-time metric taken by some as a reasonable proxy for stock selection. On the other hand, tracking error is more of a historic time-series measure; he says both should be considered, along with other measures, when determining an investors’ real skill.
No benefits
Murray references the work of academics Mezrich and Ishikawa who found no particular performance benefit associated with high active share, particularly in the past decade.
Given that the majority of benchmark indices are capitalisation-weighted, Hermes’ own research found that the more top-heavy an index is, the lower the active share that funds competing against it will tend to have, relative to other indices in which stock weights are more evenly dispersed.
He explains: “Consider, single-country indices that are dominated by a small handful of securities accounting for more than half of the benchmark’s total market capitalisation. Managers running portfolios against such indices naturally find it harder to generate high active share – particularly since a holding in the dominant firms is almost essential for controlling risk.”
Murray’s paper ‘Looks like a Lion, Manages like a Lamb’, warns that growing investor reliance on active share is materially oversimplifying the complex fund selection process.
“It is not sufficient only to have the skill to identify opportunities; it must be allied with an ability to construct portfolios so that the size of individual positions will be commensurate with the size of the opportunity and the risk taken,” he adds.
“Active share holds a great deal of practical utility for assessing active managers, but cannot be used in isolation, and will be one in a set of tools available for investors trying to identify managers that are capable of delivering desired outcomes.”
