Morningstar - Q1 2022 - 44

Strategies
1.0
1.5
EXHIBIT 3
High Concentration The higher a fund's active share, the more concentrated
its top 10 holdings.
Quintile 1
Quintile 5
Quintile 5 Minus Quintile 1
Average Active Share and Average Assets in Largest 10 Stocks by Select Categories and Active-Share
Quintiles as of Year-End 2020
Large Growth
Mid-Cap Growth
Quintile 5
Quintile 1
10
20
30
40
60%
Assets in Top 10
Source: Morningstar. Data as of 12/31/2020.
Note: The dots for small blend and small value overlap. This illustration excludes large-blend and large-growth categories, given that their respective
indexes' unusual top-heaviness in recent years has contributed to a substantial narrowing of the differences between their quintile concentrations.
70
80
90
100
Mid-Cap Value
Mid-Cap Blend
Small Blend
Small Growth
Small Value
Active Share
50%
0.5
The Bottom Line on Active Share
Active share isn't without value. The connection
between a portfolio's differentiation from
its index, its concentration, and volatility can
help classify funds by their investing style
and risk level. But active share is fraught with
pitfalls when used as a tool to identify
superior active strategies.
Funds with high active share are relatively
expensive and have an undesirable risk
profile over the long run. While it's true that
the best-performing funds tend to be those
with high active share, the same is true for the
worst performers.
as measured by the percentage of assets in
their top 10 stocks-relative to peers and,
therefore, less stock-level diversification. This
magnifies the impact of investment
mistakes and the risk of missing out on the
market's biggest winners.
EXHIBIT 3 illustrates the positive relationship
between funds' average active share and
concentration of assets in relatively few stocks.
High-active-share funds congregated in the
upper right of the scatter plot, demonstrating their
propensity to concentrate their portfolios.
The more diffuse portfolios of funds with low
active share led them all to the bottom left.
The relationship between a portfolio's
concentration and active share generally held
across all categories since 2002.
A Lost Decade for Highly Active Managers
While highly active managers demonstrated some
skill over the 18-year period through 2020,
their superiority was mostly limited to the earlier
half of that span. Their results from 2011
through 2020 give them little to brag about.
44
Morningstar Q1 2022
Relative to lower-active-share peers, their
before-fee results during that 10-year span were
among the worst in seven of the nine categories
and dead last in five. Only the high-active-share
quintile within the small-growth category
showed excess gross returns-0.5 percentage
points annualized-while posting excess returns
of negative 1.0 percentage point or worse
in six categories. The lowest-active-share quintile
performed best in four categories.
High-active-share funds failed to deliver superior
net-of-fee results in any category during the
10-year period.
The results as measured by success rates are also
ugly for the most differentiated portfolios.
Rather than offering their categories' best chance
of survival and outperformance, as they had
during 2003-20, large-cap funds ranking above
the 60th
percentile on active share (that is,
quintiles 4 and 5) had their respective categories'
worst success rates from 2011-20. Funds
with relatively low active share (quintiles 1 and 2)
had the strongest success rates in six of the
nine categories.
There is little use in applying active-share screens-
a minimum threshold, for example-to funds
in the small- or mid-cap categories because
the high-active-share cohort posted among the
weakest results within mid-caps from 2003
through 2020, and its advantage within small caps
was statistically insignificant. The before-fee
advantage for high-active-share funds has
been statistically significant only for large-cap
categories.
These findings should not be taken as a signal to
swear off highly differentiated funds. Across
all domestic categories, there are funds with high
active share whose skilled portfolio managers
and strong, risk-minded investment processes
make them worthy long-term holdings.
Instead, these findings serve as a cautionary tale
for asset owners or advisors tempted to pay
more than they should for funds with second-rate
investment teams or poorly devised processes
that can lead to volatile and inferior net returns.
With higher active share comes a higher risk
of disappointment. K
Robby Greengold, CFA, is a strategist at Morningstar
Research Services LLC.
The author wishes to thank Alec Lucas, Katie Reichart,
Dan Culloton, Matias Möttölä, Mathieu Caquineau,
and Kathryn Wing for helpful comments, discussions, and
technical expertise.

https://www.morningstar.com/authors/2146/robby-greengold

Morningstar - Q1 2022

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