Morningstar Magazine - June/July 2018 - 88

Investors

Active vs. Passive Redux
How far should managers go?

Undiscovered Manager
94

A Focus On Essentials

101

Dressing for an Amazonian Storm
Sector Snapshot: Consumer Cyclical

MORNINGSTAR CONVERSATION

John Rekenthaler

Sector Rap

102

User Profile

Retirement Planning Is Just
the Beginning

How active should active managers be?
An increasingly popular argument contends that if
you are going to be active, you should go all
the way and be very active. The New York attorney
general joined the debate recently when
it asked large asset managers to publish their
funds' active share metrics to help investors
determine whether active fund costs are justified
compared with cheaper index funds.1
I wanted to explore that concept, and I also
wanted to look at the reverse, which is
not as often discussed: Should passive strategies
be very passive, or should they incorporate
active bets? On April 9, I convened a panel of three
industry experts: Martijn Cremers, professor
of finance at Notre Dame and co-creator of active
share; Ben Inker, portfolio manager and
leader of the asset allocation team at GMO; and
Ben Johnson, director of global passive
strategies research at Morningstar. Our conversation has been edited for length and clarity.
John Rekenthaler: Martijn, can you explain your work

on active share?

Martijn Cremers: Active share is a measure
of how much security selection the fund engages
in-a tool that compares the holdings of a
fund to the holdings of a benchmark. In particular,

active share is the percentage of holdings
(or portfolio weights) that doesn't overlap with the
holdings of the benchmark. Another measure,
of course, is tracking error, which measures how
different the returns have been.
Our original active share research2-a joint work
with Antti Petajisto-found that, particularly
around the early 2000s, a lot of actively managed
funds had really low active shares, and that
those funds with low active shares that were not
also inexpensive strongly underperformed.
More recently, I looked at active share in
combination with other dimensions, such as fees.3
I found that it's not a problem to have low
active share, as long as the fund is relatively cheap.
As for why high active share funds may
outperform, active share may matter more for
funds that have better stock-picking opportunities,
like small-cap strategies, and strategies
that require the courage of one's convictions,
like being patient.
There are various ways of being active, right? Through
security selection or concentrated portfolios,
or by making big industry or theme bets, which might
not trigger the active share measure.

Ben Inker: If you are making your bets in
industry or country or regional ways, that is less
likely to show up as really high active share
than a highly concentrated portfolio of 10 or 20
stocks is. At GMO, we make style bets, industry

1 New York Office of the Attorney General. 2018. "Mutual Fund Fees and Active Share." April: https://ag.ny.gov/sites/default/
files/ny_ag_report_on_mutual_fund_fees_and_active_share.pdf.
2 Cremers, M., & Petajisto A. 2009. "How Active Is Your Fund Manager? A New Measure That Predicts Performance."
Review of Financial Studies, Vol. 2, No. 9, pp. 3329-3365.
3 Cremers, M. 2017. "Active Share and the Three Pillars of Active Management: Skill, Conviction, and Opportunity." Financial
Analysts Journal Vol. 73, No. 2, pp. 61-79.

Morningstar June/July 2018

https://ag.ny.gov/sites/default/files/ny_ag_report_on_mutual_fund_fees_and_active_share.pdf https://ag.ny.gov/sites/default/files/ny_ag_report_on_mutual_fund_fees_and_active_share.pdf

Table of Contents for the Digital Edition of Morningstar Magazine - June/July 2018