Active share will become an increasingly important metric for investors / distributors, which can advantageously be used to select which funds fit into the riskier allocation sleeves of portfolios / shelves, notes Credit Suisse
Craig Siegenthaler and team at Credit Suisse Equity Research in their June 3, 2015 research note “US Asset Managers” points out active managers will need to decide how they can evolve to compete against the advantages of the ETF structure versus open-end mutual funds.
Key role of active share
Tracking the genesis of active share, the Credit Suisse analysts point out that active share was introduced by the Yale School of Management in 2006 to measure the proportion of stock holdings in a fund’s composition that were different from its benchmark. They note low active share funds gained considerable market share over the last thirty years due to the growth of U.S. retail and the DC channel, and lower capacity constraints.
Siegenthaler et al. believe active share can be effectively used in combination with tracking error and historical relative performance to select which funds fit into the riskier allocation sleeves of portfolios. The following charts capture the correlation between fees and active share:
Further elaborating on the concept of active share, the analysts point out that a portfolio that is identical to its benchmark would have an active share percentage of zero. They note that sources of active share include: (i) holding different weightings of stocks versus the benchmark, (ii) excluding stocks that are in the benchmark, and (iii) adding stocks that are not in the benchmark.
Focusing on “barbelling”, the analysts note barbelling has created opportunities for both alternatives and active equity specialists. Thanks to its liquidity, low risk, low fee, and tax efficiency advantages, Siegenthaler et al. note the other half of the barbell (ETFs/ passives) is already gaining share quickly across key U.S. retail channels:
Secular shift from mutual funds to ETFs
The Credit Suisse analysts point out that ETFs were initially products that were “bought” and not “sold”, and hence it took 15 years for ETFs to become relevant. However, they point out that now ETFs are sold too, thanks to new regulations in the U.S. and Europe. They point out that while ETFs will still likely gain share in the more mature “bought” channels, one could witness much higher growth opportunities in the newer “sold” channels as well, such as the broker / dealer and the DC channel.
Siegenthaler and team believe active managers will need to decide how they can evolve to compete against the advantages of the ETF structure versus open mutual funds.
Turning their focus to alternatives, the CS analysts note a strong performance across illiquid alternatives has and will likely continue to drive large capital raises for the sector. They note while the alts have been grabbing assets, businesses, and people from large banks for a long time, this trend accelerated following the financial crisis, and should continue for the next five years:
The team also initiated coverage of five small cap asset management firms in their research report. Their coverage universe of U.S. asset managers was deepened with the induction of (i) three traditional active managers (APAM, MN, VRTS), (ii) one high growth ETF manager (WETF), and (iii) one market leader in the high growth alternative credit segment (ARES). The following chart captures the Credit Suisse analysts’ coverage and recommendation matrix: