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Stanislav Radchenko

Stanislav Radchenko
Head of Factor Research Group

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”Active Share” — a popular measure of how a portfolio’s composition differs from its benchmark — has been widely credited as a predictor of manager skill. Initial academic research has shown that active managers with high Active Share and low Tracking error enjoyed persistent outperformance. Conversely, managers with low Active Share scores and low Tracking Error were labelled “closet indexers” and have recently become the subject of regulatory scrutiny.

But how accurate is Active Share as a metric?  And would it be fair to all active managers if it were imposed as a one-size-fits-all regulation?

Not all researchers agree on the answers to these questions. Most studies have looked only at Active Share scores against actual fund performance, which does not control for environment.  This might lead to different factors being conflated.

To correct for this, MSCI simulated strategies and tested them under various conditions and constraints — akin to doing research in a controlled laboratory environment — to identify the true drivers of Active Share.

Through our portfolio construction experiments we found:

  • Active Share is not always linked to management skill, regardless if the manager employs a stock-picking or a factor-timing approach. Among stock-picking managers, high Active Share may be linked to performance through conviction.
  • Active Share depends on the choice of benchmark and on style tilts. With managers benchmarked to cap-weighted indexes, Active Share favors tilts towards small caps, but may penalize low volatility managers (see exhibit below).  A more concentrated benchmark usually leads to lower Active Share for the same level of Tracking Error.
  • Active Share provides additional information compared to Tracking Error, but there is substantial commonality because the level of risk aversion is a driver of both.
  • Active Share depends on active factor exposure. It is systematically higher for stock-picking managers who take on more idiosyncratic risk than factor investors.
  • Requiring managers to run high Active Share may have unintended consequences. Managers have several tools at their disposal to boost Active Share, such as choosing a different benchmark, investing outside the benchmark universe, taking on excessive Tracking Error or employing portfolio constraints. These measures have no direct bearing on performance and may even be detrimental.


Low Volatility Portfolios Achieved Lower Active Share than Small-Cap Portfolios

Active share of equal weighted random portfolios against the cap weighted MSCI Europe Index. Stocks in the random portfolios are chosen from quintiles in EUE4 size (Residual Volatility) in the left (right) panel


No one can offer any single ”silver bullet” metric that would allow investors (or regulators) to accurately rate the skill of active managers. However, in our simulations we found that Active Share must be complemented with Tracking Error-based analysis, using a suitable risk model and sensible benchmark, to enable careful attribution of manager performance and risk.

Read the paper, "Should you care about Active Share." 

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