Active’ is a curious adjective in investment. Depending on your views on what the press has got into the habit of characterising as the ‘active versus passive debate’, for example, it can be seen as either a positive or a negative. In the phrase ‘active share’, though, it tends to be thought of less ambiguously as a good thing while, to stretch our theme a little, the opposite is true of trading actively – as in often.
As you will glean from its title, these last two points are addressed in an interesting new paper from two US-based academics. In Patient capital outperformance: The investment skill of high active share managers who trade infrequently, finance professors Martijn Cremers and Ankur Pareek consider fund performance in the context of active share and the average length of time investments are held.
Active share essentially measures the degree to which the weightings of a fund’s holdings differ from those of its benchmark index. The Value Perspective has addressed the idea before in articles such as Identify more skilful fund managers, where we suggested investors ought to seek out a good stockpicking manager with high active share.
That is because previous studies, including by Cremers who defined the concept with another finance professor, Antti Petajisto, have shown high active share to be an indicator of strong relative performance. This time, Cremers, in association with Pareek, has drilled down further using data on institutional and mutual funds in the US that goes back several decades.
That may not be as long as we might ideally like but neither does it mean we should dismiss the findings out of hand. The pair split the funds into four groups – high active share/long holding period; high active share/short holding period; low active share/short holding period; and low active share/long holding period – and quite a stark pattern emerges.
Before we reveal what it is, however, it is worth pointing out that, to be in the top quartile for active share, funds in this paper required a number above 92% – remember, 0% implies a portfolio is identical to its benchmark index, with 100% meaning no overlap at all – while to be in the top quartile for holding periods required an average of more than two years.
And that stark pattern? The great majority of the outperformance of the universe of funds considered by Cremers and Pareek comes from the ‘high active share/long holding period’ group. In other words, while not specifically on the subject of value, their paper appears to show that being prepared to be contrarian and patient – as value investors often are – plays a big part in achieving strong investment performance.