3 High-Active-Share Funds We Like
Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. Active share is a popular measure of how similar a fund's portfolio is to an appropriate index. But do high-active-share funds have a performance edge? Here to discuss some new research on the topic and talk about several high-active-share funds we like is Robby Greengold. Robby is a strategist with Morningstar's manager research group.
Nice to see you today, Robby.
Robby Greengold: You too.
Dziubinski: Let's start out by talking about what active share is. This is a data point that we include on our mutual fund reports on Morningstar.com in the portfolio section. What is it?
Greengold: Conceptually, active share tells an investor the portion of a portfolio's assets that are invested differently than the index. So, a portfolio that perfectly replicates the index constituents has an active share of 0%, while a portfolio that invests only in nonindex holdings, stocks that are outside of the index, that would be a portfolio with an active share of 100%. So, a fund can achieve active share either by owning stocks that aren't in the index, or by avoiding stocks that are in the index, or by holding the same stocks in the index but at different weights.
Dziubinski: Got it. You recently examined the performance of funds that have high active share. What did you find?
Greengold: We studied both the performance of funds with high active share and those with low active share. Because one motivation we had for studying this topic was just the observation that there are many asset owners, financial advisors, investment consultants that search for high-active-share products. They find it appealing to invest with the fund that labels itself high-conviction, a best-ideas portfolio, opportunistic, or focused, concentrated portfolios. These have some appeal to a broad audience. And the commonly held assumption is that high active share is a recipe for success. You can maximize your chance of outperforming the index by looking very different from it and just let these portfolio managers be flexible and go wherever they think that the best opportunities are, and that leads to high active share. So, these stakeholders, as they're searching for funds, they will filter the fund universe on the active share. They will use the active-share metric as a minimum threshold or as a tool to rank funds by active share.
This research was simply our effort to answer the question of to what degree are these assumptions true? Do high-active-share funds have some sort of performance edge over the long run? Is that persistent over the long run? And the results don't sketch a very favorable picture of high-active-share funds. What we found from 2003 to 2020, the performance of high active share versus low active share, is that high-active-share funds do have an advantage before fees within the large-cap Morningstar Categories. But the issue is that we also looked at the fees charged by these high-active-share funds, and the fees are so much higher than those with low active shares that that performance edge was significantly eroded by the time investors actually got to take anything home for themselves.
So, what this tells us is that, yes, for investors that are searching for high active share, they might be able to find it within the large-cap categories as a performance advantage. But, really, only within the large-growth category did that remain true after fees. And the story has been much less favorable to high-active-share managers over the past decade.
Dziubinski: Robby, how should investors think about using this active-share metric? Should they use it at all? Do they need to use it in conjunction with other metrics? How should we think about it?
Greengold: I think that it's very important to contextualize any given fund's active-share metric. Well, the typical large-cap fund has a very different active share than a small-cap-oriented fund. So, what this research can be used for is to provide that greater context of how does active share vary across these categories. And I think that using active share in isolation is really tough to do, and for investors to get the most out of it, they need to bring in these other factors, which is just context-specific.
Dziubinski: Robby, there are some high-active-share funds that actually are Morningstar Medalists that we think pretty highly of. So, let's talk about a few of them today. One would be AMG Yacktman Focused Fund, which is a large-value fund and earns a fund Analyst Rating of Silver across all of its share classes. What's to like here?
Greengold: Well, the longest tenured comanagers, they have a long collaborative history, and they run a relatively concentrated portfolio much of the time that would lead the portfolio to be more volatile than its peers. But in their portfolio, they focus on financially sound companies, and they really manage this defensively, and they are also adaptable as market conditions change. So, this has really served shareholders well over the long run.
Dziubinski: Now another medalist that has high active share is Mairs & Power Small Cap, a small-blend fund, and these share classes are rated Silver. Tell us about that one.
Greengold: The management team here has been very deliberate about succession planning, very thoughtful about succession planning, and it's a well-resourced team. And the process here is really interesting where they prefer to invest with firms that are domiciled in the Midwest. And that's really interesting in the small-cap universe where they find it really helpful to be meeting with these management teams themselves, given that the sell-side coverage of these names might not be as great as for the larger caps, and they find an advantage to doing that. So, it's a really unique process.
Dziubinski: And then, lastly, Baron Discovery is another fund that has pretty high active share. It's in the small-growth category and its share classes earn Silver and Bronze ratings depending on the share class. Tell us about that one.
Greengold: Baron Discovery stands out because its comanagers have been with Baron Capital for something like 20 years together. And Baron Capital has a strong pedigree of long-term growth investing, and this strategy stands a little bit apart from that. It certainly benefits from that pedigree, but this strategy itself invests in more innovative, young companies that are really the up-and-coming growth stories that Baron may invest with over the long run. So, we have a lot of confidence in this one as well.
Dziubinski: Well, Robby, thank you for your time today and for sharing with us this new research and how we might use the active share data point a little bit more effectively than perhaps we have in the past. We appreciate it.
Greengold: Thank you.
Dziubinski: I'm Susan Dziubinski with Morningstar. Thanks for tuning in.