A manager’s conviction in the thesis underlying each portfolio company is key to long-term outperformance because conviction enables concentrating capital in big ideas. Additionally, conviction reduces the possibility of being shaken out of undervalued ideas based on short-term noise. A helpful tool to measure conviction is active share, which was developed in academia to quantify differentiation from the benchmark through stock selection.
Active share was developed in 2006 as a simplistic measure of stock selection, calculated as the size of positions that differ from the benchmark as a percentage of the total portfolio.1 Active share was conceived as a complement to tracking error, a measure of systematic risk that measures the volatility of a portfolio not explained by movements in its benchmark.2
Academic analysis of portfolio data from 1980 to 2009 found that managers have become less active over time,3 in part due to the rise of passive index investing. Average active share declined and the proportion of portfolios with high active share above 80% halved since 1980.
In contrast, the authors found that the active share of individual portfolios was persistent over time. Moreover, portfolios with the highest active share outperformed their benchmarks annually by an average of 1.13% net of fees. Their analysis concludes, “Funds with the highest active share outperform their benchmarks, while funds with the lowest active share underperform.”4
Since Cremers and Petajisto focused on U.S. equity portfolios, we recreated the academic study for global and international growth equity portfolios to see if the relationship between high active share and outperformance holds true for managers accessing a broader universe. Consistent with the academic study, we have found that both global and international growth equity portfolios with high active share have outperformed.
Global Opportunity Team portfolios
The MSIF Global Opportunity Portfolio, MSIF International Opportunity Portfolio and MSIF International Advantage Portfolio are each constructed with active share over 90% different from their respective benchmarks5 as of September 30, 2017.
To outperform across equity market cycles, investors must possess long-term conviction despite the short-term myopic focus of participants in the equity markets. Such conviction can only be built upon a foundation of core values.