Mutual funds
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In a crowded investment landscape, distinguishing between true active management and closet indexing is critical. Active Share, a concept first introduced by Martijn Cremers and Antti Petajisto, has evolved into a vital metric for evaluating equity fund strategies. With the rise of passive investing and customized portfolios, understanding Active Share is no longer optional for serious investors—it is essential.
What is Active Share?
At its core, Active Share measures the percentage of a fund’s portfolio that deviates from its benchmark index. Mathematically, it is calculated by summing the absolute differences between the fund’s and the benchmark’s holdings and dividing by two. The result is a value between 0% and 100%:
- 0% Active Share indicates a portfolio identical to the benchmark.
- 100% Active Share indicates a completely different portfolio.
For example, a large-cap equity fund with an Active Share of 85% suggests that only 15% of its holdings overlap significantly with the benchmark index.
Why Active Share Matters in 2025
Traditional performance metrics like alpha and beta often fail to capture how much “true” active management is taking place. In an era dominated by low-cost index funds and algorithmic trading, investors demand greater transparency regarding how fund managers earn their fees.
High Active Share funds have been statistically linked to:
- Higher potential for outperformance (particularly when paired with skillful management)
- Greater tracking error relative to the benchmark
- Higher idiosyncratic risk (specific to stock selection rather than market moves)
Meanwhile, low Active Share funds tend to mimic indexes while charging active management fees—a phenomenon called “closet indexing.” Regulatory pressures in the U.S. and Europe have increased scrutiny on closet indexers, making Active Share reporting a critical element of fund disclosures.
Technical Factors Influencing Active Share
Several technical considerations impact a fund’s Active Share:
- Benchmark Composition
Funds benchmarked against broad indices like the S&P 500 naturally face challenges achieving high Active Share without substantial sector or size deviation. - Market Capitalization Focus
Small- and mid-cap funds tend to show higher Active Share because benchmark indices in these segments are less concentrated than their large-cap counterparts. - Sector Constraints
Funds operating under tight sector or geographic constraints may have lower Active Share by design, not necessarily by poor management. - Portfolio Turnover
Active Share does not account for trading frequency. A fund could have a high Active Share but still maintain low turnover, especially if it takes significant positions away from the index and holds them long-term.
Active Share vs Tracking Error: Not the Same Thing
A common mistake among investors is conflating Active Share with tracking error.
- Active Share measures portfolio composition differences from the benchmark.
- Tracking error measures the performance volatility relative to the benchmark.
A fund can have:
- High Active Share and low tracking error (if its out-of-benchmark positions perform similarly to the benchmark)
- Low Active Share and high tracking error (if it takes large sector bets within the benchmark)
Thus, evaluating both metrics together gives a more comprehensive picture of fund strategy.
Practical Application: How Investors and Managers Use Active Share
Institutional investors often use Active Share thresholds during due diligence. For example:
- A minimum Active Share of 60% may be required to qualify for active mandates.
- Fund managers increasingly disclose rolling 12-month Active Share data to signal strategy consistency.
Moreover, some robo-advisors now integrate Active Share scores when recommending active funds versus ETFs, particularly for alpha-seeking clients.
Challenges and Limitations
Despite its value, Active Share has limitations:
- It does not guarantee outperformance—it merely signals differentiation.
- It can be gamed by including small allocations to off-index securities without materially impacting fund behavior.
- Comparisons across fund types (e.g., small-cap vs large-cap) must be contextual, as different benchmarks yield inherently different Active Share distributions.
Combining Active Share analysis with qualitative assessment of manager skill, process transparency, and fee structure remains the gold standard.
Also read: Risk Parity in Mutual Fund Allocation: A Quant’s Approach to Diversification
In Short
Active Share is a powerful lens to evaluate the “activeness” of equity funds, but it is not a standalone solution. In 2025’s highly competitive investment environment, informed investors and fiduciaries must leverage Active Share alongside other metrics to ensure they are genuinely accessing the differentiated expertise they are paying for. The spotlight on Active Share will only intensify, separating true active management from mere index imitation.
