A few years back, I wrote a Brief entitled Does Active Management Add Value? in which I concluded that there are very few true active managers (stock pickers) and even fewer good ones, hence my preference for index funds.

In my Brief, I pointed to some statistical weaknesses in an influential study conducted by a group of economists at Yale. (1)  In the study, they introduce a measure called Active Share, which measures the share of a fund’s holdings that differs from the fund’s benchmark. The study suggests that there are some really good active managers and that the best way to pick winning ones is to find those that pick stocks that are not in the benchmark they are measured against, i.e., those that have high Active Share. They conclude that the higher the Active Share, the better the performance and the greater the chance of beating the benchmark.

A brand new study by a group of researchers at AQR, a New York fund manager, comes to a very different conclusion. (2) Using the same data set from the Yale study, they sorted funds according to their benchmarks, of which there were 17 distinct ones in the Yale study. Once sorted, they found that high active share funds outperformed closet indexers (funds that buy the same stocks found in their benchmarks) in eight of the benchmarks but actually lost in nine.

The implication is that while those who deviate the most from their benchmark have a better chance of outperforming it, they also have an equal or higher chance of underperformance. The case for active management just got that much weaker.

(1) Cremers, Martijn and Antti Petajisto, How Active is your Fund Manager? A New Measure that Predicts Performance, Yale School of Management, 2007.
(2) Frazzini, Andrea; Friedman, Jacques and Lukasz Pomorski, Deactivating Active Share, AQR White Paper, April 2015.