Swedroe: Outperformance In Theory, Not Practice

April 26, 2017

Earlier this week, I reviewed several studies on active share and explained why it is not an indicator of outperformance. Today I’ll look at additional studies focusing on active share and fund turnover, as well as whether active share is predictive of future performance in emerging markets.

Active Share And Turnover
One of the more interesting findings on active share comes from co-authors Martijn Cremers and Antti Petajisto in their original 2009 study, “How Active Is Your Fund Manager? A New Measure That Predicts Performance.”

Cremers also co-authored with Ankur Pareek the study “Patient Capital Outperformance: The Investment Skill of High Active Share Managers Who Trade Infrequently.” This 2016 paper looks at the metric of active share from a different perspective, differentiating between those with patient trading strategies (low turnover) and those with active trading strategies (high turnover).

Among the findings in the study, which covered the 19-year period from 1995 through 2013, was that mutual funds that had stock-holding durations of less than two years generally underperform, regardless of active share.

The authors found that after adjusting the benchmark-adjusted net returns for exposure to five factors they considered (market, size, book-to-market, momentum and liquidity), the mutual funds with short fund duration and high active share produced an alpha of about -2% per year, which was statistically significant at the 5% level. Thus, we can conclude that high active share alone isn’t a predictor.

It’s also interesting to note that in footnote 6, the authors state that the findings of the original 2009 paper by Cremers and Petajisto don’t hold up in the out-of-sample period from 2004 through 2013. During this period, the top active share quintile produced a negative alpha of 2%.

Cremers and Pareek did find that “among high active share funds, patiently managed portfolios have been most likely to outperform. Patient funds are those which trade relatively infrequently, i.e., funds with long holding durations or low portfolio turnover.”

For example, they found that after adjusting the benchmark-adjusted net returns for exposure to the same five factors, on an equal-weighted basis the high-active-share, high-fund-duration (longer holder period) mutual funds outperformed by 2.3% per year (t-stat of 3.1). On a value-weighted basis, the alpha was 1.9% (t-stat of 1.9).

However, when fund turnover was used instead of fund duration, the data isn’t as compelling. On an equal-weighted basis, funds in the highest active share quintile and lowest turnover quintile produced an alpha of 0.9% with a t-stat (1.2) that wasn’t close to being statistically significant at the 5% level. On a value-weighted basis, the figures are better, with an alpha of 1.44 and a t-stat of 1.9. A t-stat of 1.96 is the cutoff for being statistically significant at the 5% level.


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