Active v Passive

Is it possible to find a simple measure that identifies skilful active managers and thus funds that will produce good returns? This is what the information ratio was meant to do, but several studies have shown there is no relationship between it and future fund performance.

Now research by Martijn Cremers and Antti Petajisto of Yale School of Management finds a strong link between ‘active share’ – the extent to which a fund’s holdings differ from its benchmark’s – and performance.

So what is ‘active share’?

Unlike the information ratio, which simply measures performance per unit of volatility, Cremers and Petajisto’s ‘active share’ looks at what is inside portfolios then finds robust links between portfolios’ profiles and future performance. Meanwhile, funds with low active share, termed closet indexers by the researchers, showed an average yearly benchmark-adjusted underperformance of 89 basis points over the same period on the same basis. Interestingly, Cremers and Petajisto’s research also found that portfolio turnover was comparatively high among closet indexers, while diversified stock pickers showed a much lower level of turnover.

Have a look at this video and make up your own mind…