John Alexander examines the use of active share, active share efficiency and peer share efficiency for institutional investors
Frequently lost among the media headlines is the value beyond returns that active management brings. This may be harder to monitor in an index fund but include:
• Diversification of strategies and styles for long-term protection from short-term fluctuations;
• The assets or segments that investments touch. For instance, a corporate pension fund may want to implement an environmental, social and governance strategy;
• Public and government relations. Many investors want to proactively avoid embarrassing media coverage or problematic regulatory scrutiny.
Active share has become a hot topic in the investment industry as part of the debate over active versus passive management. It compares the weight of individual securities in a portfolio relative to its benchmark. When a portfolio holds the same securities as the benchmark at identical weights, active share would equal zero. Similarly, a portfolio that held none of the securities in its benchmark would have an active share of 100. For most actively managed portfolios, active share falls between 60 and 90, but the range differs based on the universe. Managers picking from smaller universes tend to have lower active shares.
A high active share does not translate into higher returns than a benchmark. Actual returns are dependent on a manager’s skill.
Investors use the active share metric to measure how a portfolio is differently structured than the benchmark. But this can be deceptive and screen out managers making better investment choices that differ from their benchmark. For instance, an investor may screen out managers with active share below a certain number – that would indicate high active share. However, by doing this, they may miss out on managers who have lower active share but are making stronger returns with the bets they are making that are different from their benchmark.
For investors interested in a high active share, the key is to find managers with an appropriate level of active share who are making the right bets when they differ from a benchmark.
Another tool related to active share that investors are beginning to use is active share efficiency.
Quantitatively, active share efficiency takes the ratio of excess returns to active share. This frames the portfolio’s performance generated from benchmark deviations in the context of active share. In other words, how has this manager been rewarded (or not) versus the benchmark?
Active share efficiency is a useful measure for monitoring the value added of individual managers through time. It allows comparisons of efficiency across managers with different degrees of active management, providing a level playing field. This is critical, because managers ranking lower in active share can still be highly efficient, and can turn the active share conversation to their advantage by emphasising their active share efficiency. So, investors and their constants may prefer managers who generate the highest returns per benchmark deviation.
The clustering of active share efficiency scores for managers led eVestment to introduce another measure: the peer share efficiency score. This refinement groups managers according to styles, market-cap ranges, geographies and other portfolio characteristics, and compares a manager’s efficiency with the group. As many investors favour concentrated and unconstrained strategies, evaluating managers’ results in a focused context is important.
Peer share, a feature of eVestment’s analytics, measures the active share of an individual manager versus a peer group rather than a conventional benchmark, and provides a measure for manager selection and monitoring. Holdings of managers within the peer group are aggregated, giving each equal weight, to form a peer composite portfolio, which is used to measure an active share for each manager.
Adding in each manager’s excess returns derives peer share efficiency, to monitor active share efficiency on the relevant group of managers and holdings. Peer share efficiency can be valuable, as it compares managers on the securities the peer group actually holds, which can differ from cap-weighted or style benchmarks.
Simple active share measurements can be great tools for evaluating active managers’ effectiveness, but it is not the entire picture. By expanding active share analysis and folding in other related measures, institutional investors can better understand the performance and value of active management.
John Alexander is business development leader, consultants and allocators, eVestment