A 2015 study challenged the usefulness of active share. The authors found that funds with a high active share typically have small-cap benchmarks, while low active share funds tend to have large-cap benchmarks. The intuition is that if a large-cap fund takes a position in a stock such as Apple, it immediately introduces a significant amount of overlap with its benchmark, in which Apple also has a large weight.
A 2015 study by AQR researchers* challenged the usefulness of active share. The authors found that funds with a high active share typically have small-cap benchmarks, while low active share funds tend to have large-cap benchmarks. The intuition is that if a large-cap fund takes a position in a stock such as Apple, it immediately introduces a significant amount of overlap with its benchmark, in which Apple also has a large weight.
The authors argued that sorting funds according to active share is equivalent to sorting according to benchmark type, and that the question should be whether active share is effective for funds that share a given benchmark type. Empirically, they found no reliable statistical evidence that high active share funds outperform low active share funds after controlling for benchmark type.
A few months later, Cremers** and Petajisto*** wrote separate responses to AQR’s criticism of their active share measure. They both acknowledged that active share works for half the benchmark types but not for the other half. However, they pointed out that not every benchmark type contains the same number of funds, and that the benchmark types for which active share is effective contain the vast majority of funds.
Cremers even took a critical look at AQR’s retail funds, noting that they have a relatively low active share and a rather unimpressive performance track record, wondering if that might explain their dislike of the active share measure. All in all, it seems that the debate about active share is likely to continue.
*Frazzini, Friedman & Pomorski, “Deactivating Active Share”, working paper.
**Cremers, “AQR in Wonderland”, working paper
***Petajisto, “Response to AQR’s Article Titled ‘Deactivating Active Share’, working paper
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