Close Close

Portfolio > Portfolio Construction > Investment Strategies

Active Share Fails to Identify Winning Funds: Morningstar

Your article was successfully shared with the contacts you provided.

What You Need to Know

  • The report found that high fees and high risk cause the disappointing performance of high active share funds.
  • Morningstar found active share tends to fall as the concentration of top holdings in an index rises.
  • It notes that overall investors would be better off with low, not high, active share, funds.

Active share, which  has been heralded as an important measure to use when choosing actively managed funds, fails to identify strong performers, according to a new Morningstar report.

The fund data and research company studied the performance of open-end mutual funds across nine different Morningstar categories from 2003 through 2020. It found that even when high active funds outperformed before fees — which occurred in large-cap value, blend and growth categories — “their much-higher fees substantially eroded their edge.”

High active funds had fees 20 to 50 basis points higher than low active funds within the same category, according to the report, which was written by strategist Robby Greengold. In addition, high active funds had more risk than low active funds across all categories.

“Investors in high active share funds have mostly endured more risk while paying steeper fees for mediocre relative returns,” according to the Morningstar report.

Active share is that portion of a fund’s assets that diverge from its benchmark index and therefore differentiates a fund from its index.  A fund that precisely replicates an index has no active share; one that has no index assets has 100% active share.

The Morningstar report defined a fund’s active share relative to its peers and then compared those ranking in the lowest quintile for active share with the highest quintile.

Among its other findings, a peer group’s active share tends to fall as the concentration in the top holdings of its benchmark index increases, and vice versa, which explains why the active share in large-cap growth funds has fallen to about 60%, an 18-year low. The weighting of the  top holdings in the benchmark index, the Russell 1000 Growth Index, have reached an 18-year high. In contrast, active share in  small- and mid-blend funds (blend refers to growth and value) is 94%.

The Morningstar report concludes that for the most part, advisor clients would be better off  with low, not high, active share funds. It notes, however, that active share isn’t without value; it’s problematic when used to identify superior active strategies. Although the best performing funds tend to have high active shares, so do the worst performing funds.

“With higher active share comes a higher risk of disappointment.”