3 Low-Active-Share Funds We Like

Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. New research from Morningstar suggests that high-active-share funds as a group don't have a significant performance advantage, exhibit more volatility, and cost more. Here to unpack that research for us and to talk about several low-active-share funds we like is Robby Greengold. Robby is a strategist with Morningstar's manager research group.

Thanks for being here today, Robby.

Robby Greengold: Thank you.

Dziubinski: Robby, active share is a data point that we have on Morningstar.com on our fund report pages in the portfolio section. What is it?

Greengold: Active share is a measure of portfolio differentiation from a benchmark index. So, you can think of active share as just measuring the portion of a fund's assets that are invested differently from the index. An active share of 0%, that would be a fund that perfectly replicates the index constituents. And if you have a fund active share of 100%, the other extreme for a long-only portfolio, that would be a fund that invests with no commonality with the benchmark, all of its holdings are different from what's in the benchmark. And so, a fund can achieve active share either by owning stocks that are not found in the benchmark, or by avoiding stocks that are in the benchmark, or by owning the same stocks just at different weights from the benchmark.

Dziubinski: Makes sense. Now, your recent research found that as a group high-active-share funds really don't have that much of a performance edge, plus they tend to cost more, plus they tend to be a little bit more volatile. And that may surprise some people who sort of really look at active share as a meaningful data point. Why do you think your study results turned out the way that they did? Why is this?

Greengold: Well, I think that high-active-share funds, they showed some strength before fees. We studied a period from January 2003 through the end of 2020. We studied the domestic mutual fund universe. We studied the performance of high-active-share funds, those with low active share. We looked at the fees. There did seem to be a performance edge for the large-cap categories on a gross-of-fee basis. But, as you say, the costs of these high-active-share portfolios are significantly greater in some cases. They are greater across all categories if you compare the high active share versus the low active share. And those higher fees significantly erode the edge that we found before fees within the large-cap universe. So, when all is said and done, given the higher risk, higher volatility, given that high-active-share portfolios tend to be those that are more concentrated or otherwise just more willing to venture off into riskier securities, over that long time period, there hasn't been a significant performance advantage that really prevailed across all categories.

Dziubinski: Let's turn this on its head a little bit and talk about low-active-share funds and what you found about them in your study and what traits do they seem to have in common.

Greengold: We think about the dichotomy, low versus high active share, in context of the Morningstar Categories that these funds are operating within. So, we don't apply a specific threshold to active share, saying that active share below 60%, for example, count as low, because for large-growth and large-blend funds, 60%, that's essentially the middle of the pack, and that's understandable given the concentration of those benchmark indexes. Meanwhile, the small-cap categories have much greater median active shares. So, we think about low versus high relative to the category. So, to your question about any common traits, we specifically studied the performance and the fees charged, and on that basis, the lower-active-share products are much less expensive than those with high active share, and they tend to be less volatile and have lower tracking error or lower standard deviation of their excess returns versus the index. So, that would be some key things that I would point to.

Dziubinski: Robby, let's pivot and talk a little bit about a few low-active-share funds in their categories that we like, that are Morningstar Medalists, the first being JPMorgan U.S. Value. The share classes here earn fund Analyst Ratings of Gold and Silver depending on the share class. So, what's to like here?

Greengold: The lead manager is what stands out most about this strategy. She has been at the helm for over 15 years. She is a long-term-oriented investor, and she has done a really excellent job of finding value stocks that meet a really reasonable criteria of having both quality and low valuation. Just that combination has really worked well for her at the helm and also for investors of the strategy. So, that's one that we have a lot of confidence in.

Dziubinski: Robby, another low-active-share fund that we like is American Funds American Mutual, and the share classes here earn fund Analyst Ratings of Gold and Silver. Tell us about that one.

Greengold: This is a fund that has multiple managers at the helm, and we think that this has systemic strengths for the fund, which is relatively big at $80 billion AUM recently, and all of the managers have deep experience. They are really skilled managers, and they invest alongside shareholders. And together they ply an investment approach that is cautious and one that we really like for its ability to grow capital and generate income.

Dziubinski: The last low-active-share fund we'll talk about today is Hartford Equity Income. And that fund's cheapest share class earns a Silver rating. So, let's talk about that one.

Greengold: Hartford Equity Income is subadvised by Wellington, and at the helm is a lead manager who has been in the industry for several decades now. He is a stickler for dividends, valuation, and healthy balance sheets, and he has done a really excellent job of balancing the dual mandate of income and also capital appreciation.

Dziubinski: Robby, thank you for joining us today, not only giving us some fund ideas to perhaps pursue further, but really giving us some insights into this great new research about active share. We appreciate it.

Greengold: You're welcome.

Dziubinski: I'm Susan Dziubinski with Morningstar. Thanks for tuning in.