Is Your Large-Cap Fund a Closet Indexer?

Fund investors who prefer active management to passive management may occasionally feel like they're under attack these days. Even though most fund assets remain invested in actively managed funds, the growing amount held in index-based funds, as well as the increasing popularity of newer passive products such as strategic-beta funds, may make some who still favor good old-fashioned stock-picking feel downright defensive about their preference.

But how "active" are actively managed funds? After all, owning an actively managed fund that is really a closet index fund--meaning one whose portfolio hews closely to that of an index--is a self-defeating proposition, especially given the much higher expense ratios that actively managed funds often charge. If you prefer active funds to passive funds, chances are you'd like to get what you are paying for: management that is truly differentiating your fund from the index.

One of the best ways to measure how closely a fund's holdings mirror those of its benchmark index is to look at a metric called active share. The higher a fund's active share rating, the more different its holdings are relative to the benchmark. For example, a fund with an active share rating of 100 relative to the S&P 500 would have no holdings in common with the index, while a fund with an active share rating of 0 would have identical holdings (such as an S&P 500 index fund).

Active share statistics are not available on Morningstar.com. (Many readers have requested that they be added, and it's something we're considering for future site upgrades.) But the statistics are available on Morningstar Direct, our product for institutional investors. Occasionally Five-Star Investor likes to dip into this pool of fund metrics to highlight findings for our Morningstar.com readers. A year ago we looked at active share among the 20 largest actively managed large-blend funds (by assets) relative to the S&P 500. This year we're revisiting the topic, but opening up our search to all large-cap funds to see if any patterns emerge. Below is the list.

20 Largest Actively Managed Large-Cap Funds
Fund	Category	Analyst Rating	Active Share *	Holdings	Assets **
Davis NY Venture (NYVTX)	Lg Blend	Bronze	82.1	70	20.2
Dodge & Cox Stock (DODGX)	Lg Value	Gold	78.2	70	55.6
T. Rowe Growth Stock (PRGFX)	Lg Growth	Neutral	77.6	115	40.1
American Funds AMCAP (AMCPX)	Lg Growth	Gold	76.7	127	38.9
T. Rowe Blue Chip Growth (TRBCX)	Lg Growth	Silver	74.8	146	23.2
Vanguard PRIMECAP (VPMCX)	Lg Growth	Gold	74.8	123	40.7
Vanguard Dividend Growth (VDIGX)	Lg Blend	Gold	74.7	50	40.7
T. Rowe Value (TRVLX)	Lg Value	Bronze	73.6	116	19.6
MFS Value (MEIAX)	Lg Value	Silver	67.8	95	33.1
T. Rowe Equity Income (PRFDX)	Lg Value	Gold	67.3	114	30.2
Fidelity Adv New Insights (FNIAX)	Lg Growth	Silver	66.2	257	26.4
Am Funds Gr Fund of Am (AGTHX)	Lg Growth	Bronze	65.5	262	136.3
Vanguard Windsor II (VWNFX)	Lg Value	Silver	63.9	259	48.7
Fidelity Contrafund (FCNTX)	Lg Growth	Silver	63.2	308	106.3
Am Funds WaMu (AWSHX)	Lg Value	Gold	63.0	105	72.3
Am Funds Invmt Co of Am (AIVSX)	Lg Blend	Silver	62.9	122	71.3
Am Funds Am Mutual (AMRMX)	Lg Value	Gold	62.3	156	32.9
BlackRock Eq Div	Lg Value	Bronze	60.7	93	30.3
Fidelity Growth Co (FDGRX)	Lg Growth	Silver	60.6	367	41.0
Am Funds Fundmtl Invs (ANCFX)	Lg Blend	Gold	59.5	176	67.9
* Data as of May 21 ** Dollars, in billions All other Data as of May 27

Looking at the list reveals some interesting tidbits. First, the range of active share measurements is rather broad among these largest of large-cap funds, spanning from 82.1 down to 59.5. Clustered near the bottom are four American Funds offerings, which suggests perhaps the shop is less adventurous than some others when it comes to stepping away from the index and that its multimanager fund structure may lead to more indexlike portfolios than can be found among other large competing funds. (Keep in mind that our list includes the 20 largest large-cap funds by assets and not the 20 funds with the highest or lowest active share, so rankings do not represent where funds stand relative to all large-cap funds.)

Also worth noting is that the fund heading the list,  Davis NY Venture (NYVTX), is a large-blend fund with a relatively compact portfolio of 70 holdings as of its most recent portfolio reporting period. A little further down on the list is another large-blend fund,  Vanguard Dividend Growth (VDIGX), with just 50 holdings. Large-blend funds would seem to be at somewhat of a disadvantage relative to large-value and large-growth funds when it comes to active share because the S&P 500 has a large-blend orientation, making it more challenging for the funds to differentiate themselves, in theory at least. But more importantly, a top-to-bottom scan of the list suggests that funds with more concentrated portfolios generally have a better chance of possessing a higher active share. In other words, the fewer the number of holdings, the more a fund manager appears to be able to differentiate his portfolio from the index. This makes sense given that there are only a few hundred large-cap stocks from which managers can choose, so owning more of them is likely to make a fund look more like the index.

Don't forget that these active share numbers are a snapshot of how managers currently run their funds and that this can change over time, though additional research (not shown in the table) found that compared with last year, the active share of most funds varied by only one or two points, and none by more than five.

Whether your large-cap fund is listed here, you may also want to check out its R-squared rating. R-squared, which may be found on Morningstar.com fund pages under the Ratings & Risk tab, measures the degree to which a fund and its benchmark move in sync with one another. It's a performance-based measure as opposed to active share, which is portfolio-based. It can be another useful way to gauge whether your actively managed fund is as active as you think.