The paper whose methods we replicate is by Martijn Cremers and Ankur Pareek. It is titled:
Patient Capital Outperformance: The Investment Skill of High Active Share Managers Who Trade Infrequently
Data used: Fund holdings and returns 1990 – 2013
Key Conclusion:
“Economically, our results indicate substantial benefits from investment skill of high Active Share managers that trade infrequently, with average outperformance of over 2% per year”.
Other Key Findings:
- Outperforming funds do so by investing in stocks that other investors shun or find less attractive and sticking with these investments long enough for under valuation to be reversed.
- Relatively few fund managers combine patient strategies with high Active Share approach.
- Funds trading frequently generally underperform, including those with high Active Share.
- Among patient funds, separating closet index from high Active Share funds matters, as low Active Share funds on average underperform even with patient strategies.
The first paper by Cremers and Petajisto defining “Active Share” is:
How Active Is Your Fund Manager? A New Measure That Predicts Performance.
Data used: Fund holdings and returns 1990 – 2003
Key Conclusion:
“From an investor’s point of view, funds with the highest Active Share, smallest assets, and best one-year performance seem very attractive, outperforming their benchmarks by 6.5% per year net of fees and expenses”.
Other Key Findings:
- Funds in the top 20% of funds by active share measurement and the 4th quintile by tracking error (i.e. below 20% and above 60% of other funds), produced average excess returns of 2.76% the next year (net of fees).
- Funds in top 20% of funds by active share measurement and the top 20% of highest returns the prior year, produced average excess returns of 5.10% the next year (net of fees).
The follow up paper from Petajisto:
Active Share and Mutual Fund Performance
Data used: Fund holdings and returns 1990 – 2009
Key Conclusion:
“I found that the most active stock pickers<fn>The paper defines Stock Pickers as funds in the tip 20% of funds by active share measure and below the top 20% of funds by tracking error.</fn> have been able to add value for their investors, beating their benchmark indices by about 1.26% a year after all fees and expenses.”
Other Key Findings:
- Funds in the stock picker category that were also among the top 20% of highest returns the prior year produced average excess returns of 2.93% the next year (net of fees).
- Funds in the stock picker category that were in the smallest 20% of funds by assets produced average excess returns of 1.84% the next year (net of fees).
- Fund performance declines with age – at roughly .15 -.17% each year.
- Funds in the concentrated category that were among the top 20% of highest returns the prior year produced average excess returns of 4.70% the next year (net of fees).
The paper cited in The Small Investor’s Advantage blog post is:
Small is Beautiful” by Stan Beckers and Greg Vaughan.
Data used: Simulated Trading based on actual price and volume data for 250 Australian stocks over 3 years ended 9/30/99.
Key Conclusion:
“Net performance worsens with size. The conclusion is obviously not that small managers will outperform large ones; fund size is only one variable affecting performance. All things equal, however, a small manager has a sizable comparative advantage.”
Other Key Findings:
- A manager who has an absolute outperformance target will have no option but to become more aggressive as its asset base grows.
- Maintaining a desired style profile becomes harder as fund size grows. This is particularly true for momentum style managers.