A funds active share is calculated using the following formula.
Although it looks a bit daunting to begin with it's relatively straightforward.
What we need to do is take the weight that every asset has in the portfolio or the fund and subtract from that the weight that that same security has in the index the vertical lines then represent the fact that we need to take the absolute value of that difference, which means just ignoring any negative signs and then some the differences for all of the assets in the portfolio the total then needs to be multiplied by half or divided by 2.
We've got a very simple example to demonstrate a calculation of active share our portfolio here has three assets contained within it. We've got the waitings for the fund. We've got the waitings for the index for those three assets a b and c and to calculate active share what we need to do is look at the difference in waiting. So asset a we've got 30% in the fund and 20% in the index. So a difference of 10% for asset B, the fund is underweighted asset B by only holding 50% of the portfolio in asset B. Whereas the index has 65% waiting in asset B, despite the fact that the portfolio has underweighted this particular asset. We would still take the difference to be the absolutely different. So ignore the negative sign giving us 15% As I say overweight by 5% giving us that difference of 5% To calculate the active share we've got to add these all up to give us 30% and then multiplied by a half or divide by 2 to give us an outcome of 15% for our active share. This indicates that our portfolio has a high degree of overlap of Holdings with the Benchmark suggesting. There's not much by way of active decisions being taken by this portfolio manager.
This does look quite low but this is mainly a consequence of the low number of Holdings that we have in this portfolio.
Although active share is widely used as a measure to try and identify potential closet index funds. It does have some weaknesses as a measure firstly it is possible for a portfolio manager to manipulate the active share of their fund.
The most straightforward way that this can be done is through holding a very similar stock in the portfolio to one that is in the index rather than holding the stock in the index in the portfolio managers portfolio. For example, if a benchmark contain ConocoPhillips, one of the largest oil and gas companies in the US then a portfolio manager could instead invest in EXO mobile rather than chronico Philips, which would have result in a larger active share, but we're not materially distinguish the performance of the fund from The Benchmark since both stocks will be heavily influenced by the macro economic factors impacting on the oil and gas industry to a similar degree.
The next issue to consider is the active share will naturally differ across benchmarks making it hard to compare the active share of different funds which have different benchmarks. This is because there is likely to be higher active shares for indexes which have a higher number of constituent Securities for example funds with small or mid-cap index benchmarks are likely to have higher active shares than large cap indices since there are many more Investments that the fund could potentially hold meaning. There is greater scope for the portfolio manager to hold investments in different weightings from those that are held by the benchmark.
Finally just because the active share of a fund is low does not mean that the performance of the fund will track The Benchmark high levels of outperformance could be achieved by a fund manager on a small number of positions being different from The Benchmark in which the portfolio manager has high conviction. This may result in high outperformance Against The Benchmark while still having a low active share
