Analyzing the Role of Active Share in Active vs Passive Management Debate
In the ongoing discourse surrounding active versus passive management in India, one crucial metric has emerged as a valuable tool for both distributors and investors in evaluating funds: Active Share. This metric, often tracked by active portfolio managers, serves as an effective gauge of a fund’s level of “activeness” or whether the portfolio manager merely mimics the benchmark index.
Active Share is defined as the variance between a mutual fund scheme’s portfolio holdings and those of its benchmark index. For instance, if a specific stock holds a 5% weight in the portfolio but only a 2% weight in the benchmark index, that stock’s position contributes 3% to the overall Active Share of the portfolio.
By aggregating all such positions, we arrive at the Active Share of the overall portfolio. It is important to note that Active Share calculations consider the absolute difference between holdings, disregarding any overweight or underweight positions. Consequently, a passively managed fund would theoretically have an Active Share of zero, while a portfolio comprising stocks entirely outside the benchmark would boast an Active Share of 100%.
For investors seeking genuinely active management, funds with higher Active Share may hold greater appeal. Higher Active Share is a means of achieving results distinct from the benchmark, potentially leading to outperformance if investment decisions prove favorable. However, it is worth noting that higher Active Share may also entail higher active risk. This risk can be mitigated to some extent through diversification across a sufficiently large number of stocks.
Several additional points merit attention regarding Active Share. Firstly, Active Share for a given portfolio may change over time. Secondly, two portfolios with similar Active Share can exhibit vastly different levels of risk. For instance, one portfolio might have exposure to defensive stocks outside the benchmark, while another might lean more towards high beta stocks.
Lastly, Active Share can be derived from a few large, concentrated positions or diversified across numerous stocks. These nuances give rise to distinct risk-return characteristics in the portfolio, which Active Share alone cannot capture.
Combining the concept of Active Share with measures like Tracking Error, which measures the deviation of a scheme’s return from its benchmark index using statistical tools such as standard deviation, enables a more comprehensive evaluation of volatility in returns relative to the benchmark. This assessment helps gauge the impact of active risk undertaken in the portfolio.
The objective is to gain a deeper understanding of the portfolio manager’s activity and the sources of their returns. Nonetheless, a consistent track record of higher Active Share can serve as a promising starting point when shortlisting active managers for those considering allocations to actively managed equity schemes.
In conclusion, understanding the Active Share of an equity fund is a crucial question for investors to pose to their advisors and fund managers, as it sets expectations regarding the nature of their investments from the outset.
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