Mendoza School of Business

The More ‘Active’ An Active Fund Is, The Better, Researcher Says

Published: February 17, 2017 / Author: Financial Advisor

We could be asking the wrong questions about active versus passive management, a researcher says.

While most active funds fail to outperform their benchmark indexes over the long term, research from Martijn Cremers, the Bernard J. Hank professor of finance at the University of Notre Dame, has found that the more actively managed a mutual fund, the more likely it is to outperform.

“If you buy an active product, you pay a much higher fee, so you want to make sure that the active product is actually different from the passive products out there,” Cremers says. “If the difference in holdings is not very substantial, it’s unlikely that the fund is going to deliver value for investors, particularly if the fund is not very cheap.”

A recent paper, “Active Share and the Three Pillars of Active Management,” reinforces Cremers’ previous findings on “active share,” a quantitative measure of what percentage of a fund’s portfolio deviates from its benchmark.

A fund with a zero percent active share would precisely replicate its benchmark, while a fund with 100 percent active share would have no overlapping holdings with its benchmark at all.

“A low active share for a large-cap fund is 68 to 70 percent,” Cremers says. “Twenty to 30 percent of large-cap funds have active share that low.”

Read the entire story on the Financial Advisor website.