Active Share

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Active Share Definition

Active share, in portfolio management, refers to the metric that allows an individual to measure the difference between portfolio holdings and their ability to outperform the market. The main idea of this concept is to let portfolio managers grasp the actual performance of their holdings compared to market indexes. 

Active Share

Active share portfolio is one of the important yet useful metrics for managers. It helps in understanding the relationship between portfolio and management. Depending on the fund's positioning, its value can be positive or near zero. However, it still needs to show a clearer picture of the market.

Table of contents
  • Active share, in finance, refers to the portfolio indicator that helps the managers notice any difference between the fund and the index's performance. 
  • The concept was introduced in 2006 by Martijn Cremers and Antti Petajisto. However, it was published in the article "How Active is Your Fund Manager?" in 2009. 
  • Its formula is the sum of the weights of the portfolio assets less the index performance. It helps the investors when high active management fees are charged. 
  • A higher share indicates more diversion and a lower value is almost on par with the market. 

Active Share Explained

Active share is a crucial indicator that portfolio managers use to understand how their holdings perform compared to the market. It helps to determine the deviation from the rest of the market. Other researchers have also used this metric in predicting a fund's performance. 

This concept was stated in 2006 by two researchers, Antti Petajisto and Martijn Cremers. However, it was later published in 2009 in the article "How Active is Your Fund Manager." During their study at Yale School of Management, they stated a positive correlation between a fund's performance and the market. Earlier tracking error and active share did have a positive correlation.

In addition, both (Petajisto and Cremers) argued no relation between tracking error and active share. Despite this, low tracking errors can have high active share value. Besides, it also stated that portfolios with greater share value had a strong yearly performance. However, they have smaller assets under management. 

Active share plays a vital role in active management. It is measured in percentages between 0% to 100%. It states that high active share value shows more diversion from index performance. In contrast, a smaller value has almost no difference with the market's performance. So, if the value is below 60%, the index fund will match the index's performance in the market. In contrast, a high active share (around 100%) will have nothing in common with the market index. However, it can cross 100% for hedge funds as it involves long and short (buying and selling) positions. 

This indicator proves to be a useful tool for investors and portfolio managers. It helps investors in detecting areas that impose excess active management fees. However, it does have some limitations to the concept. In some cases, these shares do not give the right predictions. It depends on the manager's trading skills. Also, weights play a significant role here. So, if a fund has good quality stocks, but the manager fails to trade them, then the active share value will be high. 

How To Calculate?

Let us look at the active share formula to comprehend the concept better:

Active Share Formula

where,

w = asset's weight (the number of shares multiplied by its price).

w fund,i = the fund's weight

w index,i = the collective weight of the entire index.

N = the total number of shares in that particular index.  

Examples

Let us look at some examples to comprehend the concept better:

Example #1

Suppose Fredrick is a portfolio manager working in Guardian Assets Ltd. They operate and handle assets of different funds. However, Fredrick calculates this share percentage of the growth funds. So, let us use the formula for calculating the value.

Example 1

                       = 1/2 * |100% - 45%|

                       = 1/2 * |55%| or 55%

                       = 27.5%

Here, 100% refers to the weight of the growth fund. In short, it refers to the percentage this fund holds in its entire portfolio. As a result, in this case, the entire fund comprises stocks in the growth sector. Whereas, compared to the market index, the share of the growth fund is only 45%. Thus, the active share of the portfolio is 27.5%. It depicts that the growth fund is less diverted from the index's performance.

Example #2

Consider a manager who handles different stocks in the portfolio of his client. In addition, each fund comprises different assets. So, let us look at them:

StocksPortfolio (%)IndexDifference
Apple Inc45505
CVS Health301515
Mondelez International123018
Eagle Materials1358
Total10010046

 Active Share = 1/2 * 46% or |46|

=23%

Here, the active share value is 23%, which shows how close the portfolio is to the market index.

Active Share vs Active Risk

Although active share and risk correlate, they have wide differences. So, let us look at them:

DifferencesActive Share Active Risk
MeaningIt refers to an indicator that calculates the difference between a portfolio and a market index.Active risk is the risk associated with a particular portfolio compared to the index performance.
PurposeTo measure how the portfolio diverts from the market performance.To provide insights about the fund and calculate its risk.
Also known asNo such synonymsTracking error
Effect by cross correlationThere is no effect seen on it.Highly affected by the cross-correlation on the securities.  
ControlEffect by cross-correlationHere, the manager cannot control the risk.

Frequently Asked Questions (FAQs)

1. Is active share a percentage?

Active share is a metric that gauges the difference between a portfolio and its benchmark index. It is a percentage of the number of stocks in a portfolio and its difference compared to the market index. However, while calculating this percentage, the value is in modulus, which later converts into a positive correlation. 

2. What is a good active share number?

Although there is no metric to understand a good number, the percentage lies between 20% to 100%. If it is between 20-60%, it is closely linked with the market index. In contrast, a percentage of more than 60% is highly diverted from the index.

3. Should active shares include cash?

Active shares give a measure of active management of portfolios. These shares should include both cash and other securities. According to CFA, including cash and other equity in its calculation is an important step.