Is your active fund 'active'?

Summary: Active share measures how different a fund's portfolio is from its benchmark. A high reading means the manager is making bold, independent bets. It says nothing about whether those bets will work. And the data makes that gap uncomfortably clear.

Summary: Active share measures how different a fund's portfolio is from its benchmark. A high reading means the manager is making bold, independent bets. It says nothing about whether those bets will work. And the data makes that gap uncomfortably clear. Every active fund manager makes the same implicit promise: their portfolio will look different from the index and that difference will be worth the higher expense ratio you pay. A simple metric that measures this difference is active share. It tells you how much a portfolio differs from its underlying benchmark. One can calculate it by adding the difference between each security’s weight in the fund and in the index, and dividing the sum by two. See table: How to arrive at a fund’s active share. An active share of 80 per cent means the portfolio is roughly 80 per cent different from the index and that the fund manager is taking substantial active calls. A fund with a 10 per cent active share is more or less an index fund.  Since higher active share indicates more active management, it is reasonable to think that such funds should outperform their benchmarks, with greater divergence driving better returns. But as our exercise in this story shows, that is not reliab