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Why Active Funds Outperform Closet Index Funds

Yale professor Martijn Cremers explains why funds that hew closely to their index tend to underperform their more active brethren.

Christine Benz: Hi, I'm Christine Benz for Morningstar.com here at the Morningstar Ibbotson Conference. Today, I had the pleasure of sitting down with Martijn Cremers, he is a professor at Yale University and he is also the co-author of some recent research that attempts to identify how active certain mutual funds truly are.

Martijn Cremers: Active share is a new measure of active management. It compares the holdings of a fund to the holdings of its benchmark. So, if the holdings or the investments in the funds are very similar to the holdings of the benchmark we say the fund is not very active in terms of its holdings, and it could be closet index fund. If the holdings are very different, and so the fund invests in very different stocks than are in the benchmark, or the weights are very different, than it will have a high active share.