Investors are starting to think twice about active share. It’s about time. While active share is important, our research shows that it is just one of several ways for skilled equity portfolios to express high conviction.
Since 2009, high active share has been seen as a hallmark of conviction in equity investing. The term was coined by Martijn Cremers and Antti Petajisto, as a measure of how much a portfolio differs from a benchmark. Yet recent data from eVestment show that investors are scaling back their searches for portfolios with high active share. The rolling six-month average of searches using an active share screen plummeted from its January month-end peak of more than 27,000 searches per month to roughly 6,000 searches ending September, according to eVestment.
Differing from the Benchmark Isn’t Enough
Investors have often searched for high active share and low name count—holding a small number of stocks in a portfolio—to capture conviction in equity portfolios. But these measures aren’t the only ways to determine whether a portfolio manager has conviction. And they don’t tell you anything about how a portfolio is managed. For example, a high-active-share portfolio may differ sharply from the benchmark yet end up with large positions in stocks that underperform. And without a clear investment philosophy, high active share provides no intelligence on how a portfolio is positioned or how it will perform in changing market conditions.
Not every portfolio will benefit from a higher active share or more concentration. In fact, the “sweet spots” differ from group to group. Our research identified US large-cap equity managers who finished in the top half of performance from 2004 to 2014 as skilled managers. We then studied the characteristics of this group to understand what was behind their outperformance.
Think Differently About Conviction
In the dividend-yield category, for example, skilled high-conviction managers held, on average, 75 stocks and had a 75% active share from 2004 to 2014 (Display). These are a higher number of holdings and a lower active share than are often referenced in traditional definitions of conviction. Here, conviction is expressed by risk-taking through yield exposure—and rewarded with a premium of 1.9% a year to the benchmark, over time, as shown in a previous blog.
It’s also clear that the sweet spot for high active share is less important for some strategies than for others. For example, in value portfolios, the best results were in portfolios with an average of 83 stocks and an active share of 76%. This observation is important. In value, individual value stocks have more single-stock volatility because they face uncertainty in regard to future earnings outcomes. In this case, building a portfolio with low name count or higher active share may result in taking on risk that isn’t necessary in order to be rewarded.
Looking Beyond Active Share
The range of active share across high-conviction managers varies significantly by category. In the value group, for example, the range was quite wide, with the lowest decile averaging just 64% active share, while the highest decile came in at 88%. This is an indication that high active share may be an outcome for some, but not all, skilled high-conviction managers in this category. Over the period we studied, the ranges for skilled high-conviction managers in dividend yield, value, quality and low beta were widest.
Don’t rely solely on high active share as a stamp of high conviction. To be effective, high-conviction investing also requires a clearly defined angle on the market, a disciplined investing process and skill. By understanding how much active share is optimal for different types of strategies, investors can make more informed decisions when screening or selecting managers to ensure that they don’t take more risk than necessary.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.