it is precisely during times of unrest and when investors are showing signs of
panic that active managers have the greatest edge.
– søren Milo christensen portfolio manager sKAGEn Global
Tumultuous times often lead to fear which causes share prices to diverge from the fundamental values in companies. Histori- cally speaking these periods have created good opportunities for active managers with a long investment horizon, who have the freedom to choose companies irrespec- tive of index, region or sector.
it has long been debated whether it is best to invest in an index fund, so-called passive management, or whether one should instead invest in an active manager who seeks to create excess return.
Although the debate has been raging for many years, it remains remarkably unba- lanced
How active is active?
An important, but little used measure that should be taken into account when selec- ting an active manager is active share. simply put, active share demonstrates how much of a fund is invested differently to the index.
An active share of 30 percent, for example, means that 30 percent of the fund diverges from the index. in other words, 70 percent of the fund is identical to its benchmark. Active share is a good way for fund investors to assess whether they get what they pay for when it comes to active management.
This can best be illustrated by an example. let’s take a fund with an active share of 30 percent and a fixed manage- ment fee of 2 percent. Then assume that the 30 percent that is invested differently to the general market provides a very respec- table excess return of 5 percentage points. The manager will thereby have created an excess return for the entire fund of 1.50
percentage points (before fees). nevertheless, although the manager has picked the right stocks, fund savers actually end up with a relative return of minus 0.5 percentage points, after fees. With an active share of 30 percent, and a fixed management fee of 2 percent, the manager must create an excess return of almost 7 percentage points in the active part of the portfolio just to cover the fixed
Closet indexers dominate
in reality, a fund with low active share is invested almost identically to the general market. As such, statistically speaking, it is impossible to beat the market in the long run. These types of managers are known as closet indexers.
Moreover, history has shown that the proportion of closet indexers – that is those with an active share of less than 60 percent – has been increasing.
in contrast, sKAGEn Kon-Tiki had an active share of 96 percent at the end of 2013. Active share in sKAGEn Global and sKAGEn Vekst was 95 percent and 94 per- cent respectively at the same point in time. sKAGEn’s value-based investment philo- sophy is viewed by many as one of the main reasons behind its success. but perhaps just as important is the portfolio managers’ freedom to pick companies in the portfolios themselves, far from the world’s financial centres and groupthink mentality.
Faulty empirical data leads to faulty conclusion
deliver poorer returns than the general market. The problem is that the analyses contain data from a large range of suppo- sedly active managers, which do not have a chance of beating the market.
A very different picture emerges if one carries out a more nuanced analysis of active managers. The fact is that truly active managers – i.e. those with an active share of more than 60 percent – on average beat the market after costs.
based on the table below, we can draw three general conclusions:
1) Active managers beat the general market – before costs.
2) Those with high active share beat the market more than those with low active share. The reason for this is not that those with low active share pick the wrong stocks, but that a large part of the fund is invested identically to the index, hence the combi- ned excess return is minimal.
3) Managers with low active share therefore do not create excess return large enough to cover their fees.