The Newest Buzz "Active Share"

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Leave it to the financial industry to come up with new fancy buzz words and catch phrases. A new term that has been getting a lot of attention lately is something called “Active Share.” This is a measurement that shows how active a portfolio manager is and how much their fund differs from their respective benchmarks.

“Active Share” is a concept developed by a pair of former Yale professors, Martijn Cremers and Antti Petajisto. It measures how much a fund differs in composition from its benchmark index. A fund is considered to be “moderately active” when 60% to 80% of its holdings are different, and “truly active” when the score is more than 80%. The higher the score a manager receives, the more active the manager is (or the more differently the fund looks from its benchmark).

The professors also categorize funds under 60% as “closet indexers.” Closet Indexing is another fun catchy phrase meaning a non-index fund with low active share that looks and performs very closely to its respective benchmark. Our views are that this is very poor if you are paying a management fee, and getting only the return of the index (or lower) with very little active management.

The professors’ research produced a rather good news/bad news result. They found the higher the Active Share, the higher the returns. Unfortunately, their work also shows that 70% of Canadian equity funds don’t qualify as being actively managed.

Here are some of our more frequently used mutual funds and their respective Active Share:

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Source: All calculations were provided by their respective mutual fund companies and are believed to be accurate and true.

For many years (and for Dad’s entire career) we have recommended managers who do not follow the herd, are bold enough to invest in their highest convictions and are not afraid to look different from the stock exchanges. Although we do not advocate Active Share as the only consideration when choosing a fund, we believe having a higher active share is one aspect that will lead to better returns over the long term. It is nice to know that we are not alone in our theory and that there is actually a mathematical equation that proves it works. We thought it was interesting and hope you do to.

Thank you, Andrew & Peter

#investing

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