Comments on: Active Share: Not an infallible metric

By: Dale Rathgeber

Dale Rathgeber — Sun, 21 Mar 2010 17:35:31 +0000

@ You know perfectly well who the “losers” are in a pure mathematical sense; so do I. I was simply making the point, that in a broader sense, closet indexers are the “losers” because they probably believe they are in an “active” fund when they are not, and hence they are stupidly paying a 2.7% MER, when they should be paying .17%. My other rant stems from my observation that index-zealots are, to my way of thinking, obsessed with the “wrong” tools for measuring their performance. “Alpha” is a slide-rule, and it has it’s place, but index-zealots should put down their slide-rules and use their telescopes more often.

I am now prepared to let you have the last word.

By: Canadian Capitalist

Canadian Capitalist — Sat, 20 Mar 2010 21:56:23 +0000

@Dale: I’m perfectly aware of the sources of alpha, thank you very much. But you seem to have forgotten that the discussion in this post is on Active Share, specifically the findings by Cremers and Petajisto that stock pickers are able to generate alpha net of expenses. The funds that make factor bets have not generated positive alpha, so it is moot to discuss them here:

“Economically, these results suggest that the most active diversified stock pickers and concentrated stock pickers have enough skill to generate alphas that remain positive even after fees and transaction costs. In contrast, funds focusing on factor bets seem to have zero to negative skill, which leads to particularly bad performance after fees. Hence, it appears that there are some mispricings in individual stocks that active managers can exploit, but broader factor portfolios are either too efficiently priced to allow any alphas or too difficult for the managers to predict. Closet indexers, unsurprisingly, exhibit zero skill but underperform because of their expenses.”

By: Dale Rathgeber

Dale Rathgeber — Sat, 20 Mar 2010 00:25:31 +0000

CC In your thought experiment and the later musings, it seems that you have equated “average performance” with “index performance”. They may often be similiar, but they are not identical. Your whole notion of “alpha” as a useful yardstick seems to be result from your equation as well. It seems to me that over-perfoming an index can result from myriad factors including: holdings which differ from a chosen index, weightings, MERs, cash, turnover frequency, and the constituents (and weightings) of the index arbitrarily chose for comparitive purposes. Perhaps the biggest factor is “Omega”, which will be explained in greater detail in the newest blog on the block, “The Other Canadian Capitalist”. Have a good weekend. PS……… I don’t like the light blue sub-headings in your new format………..
PS 2…….MoneySense hasn’t been around sufficiently long for it to be hailed as Canda’s best PF magazine—(although it is very good); the title goes to Cdn Money Saver.

By: Canadian Capitalist

Canadian Capitalist — Fri, 19 Mar 2010 19:48:13 +0000

@Dale: Have you read the Active Share paper? If you have, how do you infer that the “losers” are the closet-indexers? The paper does support the notion that a fund that pretends to be active but hugs the index trails the benchmarks. Of course it will. If I have an index fund and charge investors 2%, it shouldn’t be surprising if my performance trails the index by 2%. Investors in the fund are losing to fees, not to other active investors. If truly active investors are able to earn alpha, they should be getting it from somewhere. My question is where? And what makes you think this excellent state of affairs will last (after all, the 14 year period of the study isn’t really long-term by any stretch of the imagination)?

By: Dale Rathgeber

Dale Rathgeber — Fri, 19 Mar 2010 15:33:31 +0000

@CC Your “thought experiment”, now clarified to deal with Kim’s valid point, isn’t as inane as I first assumed. The “losers” are the investors in closet-index funds who are stupidly paying a 2+% MER for a fund which isn’t “actively” manged at all. I was “jumping up and down” because now that you are part of Canada’s “finest personal finance mag” (or whatever you called it) your humble readers will be holding you to an even higher standard.

P.S. I’m starting my own blog, to be called “The Other Canadian Capitalist”.

By: Canadian Capitalist

Canadian Capitalist — Fri, 19 Mar 2010 13:35:36 +0000

@Kim: The example in this post is vastly simplified. Studies have shown that mutual fund portfolios in aggregate resemble their index. What I’m saying is that even if all the mutual funds have a high active share (for example, if there are just 10 funds invested in the S&P 500 and each of the fund holds 10 of the 500 stocks in the index, assuming equal weight, the active share for the funds will be 90), but the majority of them will under perform the index because of their fees. In fact, the paper itself points out that mutual funds used to have high active shares but as a group they trailed the index in the past. It’s not clear to me why the data for 1990-2003 supports a different conclusion and if high Active Share funds do generate alpha, where it is coming from (because if one group is winning, it has to at the expense of someone else. The question is: who are the losers?).

By: Kim

Kim — Thu, 18 Mar 2010 22:36:31 +0000

@CC I misinterpreted your example. I was assuming that the one index stock made up only 10% of the holdings of each fund and that the other 90% was made up of non index stocks (i.e. that’s how you come up with an Active Share of 90). If each of your funds only owns one index stock and nothing else, then I’m not sure how your thought experiment is all that relevant to the Active Share concept.

By: Canadian Capitalist

Canadian Capitalist — Thu, 18 Mar 2010 21:42:08 +0000

@Kim: Someone has own the stocks in an index. In my example, each of the ten funds owns 1 stock from the index. The other 9 stocks are owned by the other 9 funds. If the other 90% of the stocks go through the roof, it will be reflected in the index performance. The index returns will be through the roof as well.

@Dale: Thanks for the reminder to reply Kim’s post. There is nothing faulty in my thought experiment. In any case, I don’t know why you are jumping up and down. Do you use Active Share to narrow your fund picks? If not, how is this relevant in any way, shape or form to what you do?

By: Dale Rathgeber

Dale Rathgeber — Thu, 18 Mar 2010 21:15:39 +0000

You never answered Kim’s post regarding the faulty reasoning in your “thought experiment”. I fear that your blind religuous faith in what Bogle has sold to you is clouding your analytical abilities. There is no need to pity us active investors; we are content in our superior index-beating results.

By: Week in Review – March 13 » 1stmilliondollar.net - A financial journey to our first million dollar

Sun, 14 Mar 2010 13:27:07 +0000

[...] Canadian Capitalist gave his opinion on recent column from Globe & Mail titled “Only the truly active fund managers lead the pack”. Is actively managed funds really better than passively managed ones? [...]