Alpha Architect’s Jack Vogel: Low vs High Active Share

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The following is an excerpt of ValueWalk’s interview with Jack Vogel, Phd, CIO/CFO at Alpha Architect. In this part, with Jack discusses how active share is used and the difference between low and high active share. Check out the full interview on ValueWalk Premium.

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Q1 2020 hedge fund letters, conferences and more

Active share, it's a common term now. What is it and how is it used?

Yeah, so active share is, um, let me maybe, like define it, right. So if you have two funds that are both long only, so imagine one is just like the S&P 500. And another is, let's say a strategy that picks dividend stocks, right. Basically, the act whatever Active share does is it compares the weights of the underlying positions of those two strategies, right? And so, for long only funds, this is going to range from zero to a 100. Zero means that fund a is exactly the same as the index. 100 means fun day has literally no overlap with the index. Right. And so, and actually, I just did a short video on this two weeks ago.

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I showed you how you calculate it. But essentially, what it does is it allows an investor to understand, hey, I'm thinking of doing this strategy. And it costs you know, let's say it costs 1%. Right?

So if it costs 1%, and it's, you can compare it now to the index fund, and say, okay, at least Am I getting something different when I buy this strategy, right? As well as it allows you to also Look at like past performance and maybe understand what happened, right? So if you have two funds that have a 99% active share difference, and then you try to say, hey, well, why did fund a do better or worse than the index?

It's because fun day was not at all like the index, it was 99% different than the index. Right? So trying to it's like comparing apples and oranges. And that's what active share allows you to do is to understand, hey, are these two things the same? Are they different? Or from zero to 100? You know, where does it, where is the overlap?

Can you use it to predict which managers who will outperform their benchmarks, if they have the high active share versus low?

So you can't you can't use it to predict right and that's where there's been a pretty good debate about this. In there's a lot of actually academic papers debating this topic, right? Is active share good bad or indifferent? I think the true answer is it's kind of indifferent. Right? And the reason is because, you know, we actually did a simulation study on our site a couple of years ago, Yang was working for around the data.

And basically what we said was you said, hey, let's just say we're going to randomly pick 50 stocks and just like throw darts at the wall, right? So if you pick 50 stocks out of, let's say, the top thousand, you're going to have a really high active share, right? Because you're only picking 50 out of 1000. And if you equal weight, you're not going to have high overlap. So you're gonna by definition, you're gonna be super active.

Now, do you beat the market? No, right? Of course you don't, you're just picking random stocks. So in that example, you had high active share, but you didn't beat the market. So what historically they found is funds and strategies that had high active share but tilted towards things that we know worked in the past like factors like value, momentum, quality low Vol. Right, those things did well, relative to funds that maybe had, you know, tilted towards factors but had super low active share, right. So it's not necessarily predictive of future performance. But it at least gives you an idea. I would say it's, it's just like a tool to use to figure out, is the fund at least doing something different than the benchmark?

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