Active Share

Active Share is a straightforward metric that measures the percentage of a fund's portfolio that differs from its benchmark index. Think of it as a “uniqueness” score for a mutual fund. Developed by academics Martijn Cremers and Antti Petajisto, this simple number reveals how much a fund manager is willing to deviate from the crowd. A fund with an Active Share of 0% is a perfect clone of its index, holding the exact same stocks in the exact same proportions. Conversely, a fund with 100% Active Share holds absolutely no stocks in common with its benchmark. For investors paying fees for active management, this metric is critical. It helps to quickly identify genuinely active funds from so-called “closet indexers” or “index huggers”—funds that charge a premium for expert stock-picking but, in reality, are just hugging their benchmark and hoping for the best.

You don't need a PhD to understand the math, which is a big part of its beauty. The calculation essentially adds up all the differences between the weight of each stock in the fund's portfolio and its weight in the benchmark index. The final sum is then divided by two. Let's use a simplified example. Imagine a benchmark index with just two stocks:

• 60% in Company A
• 40% in Company B

Now, let's look at an “active” fund run by a manager named manager Bob:

• 70% in Company A (10% more than the index)
• 20% in Company B (20% less than the index)
• 10% in Company C (a stock not even in the index)

To find Bob's Active Share, we sum the absolute differences: |70%-60%| + |20%-40%| + |10%-0%| = 10% + 20% + 10% = 40%. Then, we divide by two: 40% / 2 = 20%. Bob's Active Share is 20%. He’s barely active at all; he’s a classic closet indexer. You are paying him for his unique insights, but he’s mostly just buying the index for you.

For a value investing purist, Active Share isn't just a neat statistic; it's a fundamental litmus test. The goal of value investing is to find wonderful companies at fair prices, a task that often requires looking where others don't and making bold, contrarian bets. You simply cannot do that by hugging an index.

The core promise of active management is to beat the market. But a fund that closely mimics its benchmark cannot, by definition, significantly outperform it. After fees, it's almost guaranteed to underperform. Paying a 1.5% expense ratio for a fund with a 20% Active Share is like paying for a five-star gourmet meal and being served a lukewarm fast-food burger. You've been overcharged for an inferior product. Active Share cuts through the marketing fluff and exposes this discrepancy. It helps you find managers who are actually trying to earn their fees by building a portfolio based on their own research and conviction, not just mirroring the S&P 500.

Now, let's be clear: a high Active Share does not guarantee high returns. A manager can be very active and very wrong. It is a measure of activeness, not skill. However, it is a necessary precondition for significant outperformance. Think of it this way: to win the race, you have to actually run it, not just stand near the starting line. A high Active Share shows a manager is in the race. Your job as an investor is to then figure out if they're any good at running. This means combining Active Share analysis with other crucial factors, like manager tenure, investment philosophy, and the fund's turnover ratio. A high-conviction, low-turnover manager, in the spirit of Warren Buffett or Benjamin Graham, is often a good place to start.

The original research provides a helpful, if informal, guide for categorizing funds:

• Below 20%: Essentially an index fund.
• 20% to 60%: Closet Indexer. These are the funds to be most wary of, as they often carry high fees for their lack of independence.
• 60% to 80%: Leaning active. The manager is making some bets but is still clearly influenced by the benchmark.
• Above 80%: Truly Active. These managers are building portfolios based on high-conviction ideas and are not afraid to be different.

Active Share is one of the most powerful and practical tools to emerge from financial academia in recent decades. It empowers ordinary investors to make better decisions. Here's the takeaway:

• Use it as a filter: Screen out funds with low Active Share and high fees. They represent poor value.
• Combine it with other metrics: Don't use it in isolation. Look at tracking error (which measures volatility relative to a benchmark), fees, turnover, and the manager's long-term track record.
• Demand transparency: Ask your fund provider for their Active Share figures. The fact that they calculate and disclose it is, by itself, a good sign.

For the value investor, the ideal fund is often a potent cocktail: a high Active Share, low turnover, reasonable fees, and a manager who thinks like a business owner. Active Share is your first, best clue to finding it.