How Active Is Your Mutual Fund?

By now most people know that if you want your investments to track the market, you are better off investing in passive index funds and saving money on fees. That doesn’t mean that actively managed funds are always a worse choice, but they have to beat the market by at least the difference in fees for you to come out ahead. Which raises the question, how do you know if an actively managed fund is really out there looking for opportunities or just riding the bull market and pocketing fees?

“One of the best ways to measure how closely a fund’s holdings mirror those of its benchmark index is to look at a metric called active share,” writes Adam Zoll for Morningstar.

How Active Is Your Mutual Fund: Active share compares a fund’s portfolio to the benchmark

Active share compares a fund’s portfolio with an underlying index (often the S&P 500) and then measures how different the two of them are. An index fund with have an active share of 0, while a fund that doesn’t have any long positions in the underlying index would have an active share of 100. Looking at the 20 largest actively managed funds, Zoll found that the active share varies by more than 20 percentage points.

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How Active Is Your Mutual Fund: Concentrated holdings more likely to have a high active share

The smallest fund on the list by assets under management, Davis NY Venture, has the highest active share, but that seems to be a coincidence. There isn’t any obvious pattern between active share, analyst rating, category, or AUM, but having more concentrated holdings does seem to make things easier. Since you are choosing actively managed funds so that you can benefit from talented stock pickers, it makes sense that the funds that concentrate investments in their best ideas will be better able to differentiate themselves from the market and from competitors (outperforming either is another matter of course). Zoll points out that this list is restricted to the biggest large-cap funds and that expanding the list to small funds would reveal an even broader range of active share values.

Active share is focused on portfolio comparisons, but you can also look at the correlations between an actively managed fund‘s returns and those of the underlying index. Between these two approaches, you should have a good idea of whether you are looking at a closet indexer or a fund that is willing to move against the crowd to hunt better returns.

H/T Brendan Conway of Barron’s