The rise of passive investing, in recent years, has been fueled by
many factors. Most significant is the low volatility bull market that began in
2009, which has resulted in active stock selection becoming less of a driver of
positive results. Another factor is an increased focus on fees as a key
component of net returns. Some in the active-management community also have
contributed to the popularity of passive investing. After growth of their
assets under management, many managers begin to place more emphasis on
benchmark relative risk, and in some cases business risk, often delivering poor
returns to investors.
We believe there are benefits to owning both active and passive
strategies in your investment portfolio, but it is important to fully
understand how your active managers invest.
Active share measures the difference between a fund's holdings and
its benchmark's holdings. The greater the difference, the greater the active
share. Over the last decade, there has been much academic research on the
topic. One of the earliest studies, published in 2009, is titled “How Active Is
Your Fund Manager? A New Measure That Predicts Performance.” In it, authors
Martijn Cremers and Antti Petajisto concluded that there is a positive
correlation between a fund's active-share value and the fund's outperformance
versus the benchmark. The analysis also revealed a prevalence of “closet
indexers”—portfolio managers whose funds closely mirror the holdings of their
benchmarks, while they continue to charge typical active-management fees. The
analysis further showed that the funds with the highest active shares delivered
the best long-term performance, before and after fees.
Of course, there are many additional factors that can contribute
to outperformance, but we believe that investors should consider active share
when evaluating active portfolio managers.
At Weitz, our investment process has always been high conviction
in nature and benchmark agnostic. A byproduct of our process is that our
portfolios generally have high active share. In today's investment environment,
where investors often prefer some allocation to passive portfolios, we believe
our active investment approach represents a compelling complement to passive
strategies. For more on our approach to High-Conviction Investing, click here.