Active Investing Beats Closet Indexing

One of the most important debates in investing circles is the question of can actively managed portfolios beat passive indexes over time.

Recently two professors at Yale, Antti Petajisto and Martijn Cremers identified one of the keys to beating the index -- trying. According the Wall Street Journal, Petajisto and Cremers' research shows that funds that differ from the index have a better chance of beating the index than funds that are "closet indexes."

Petajisto and Cremers built an "active-share" measure to indicate the degree to which a fund's portfolio diverges from the fund's stated index.

According to the Journal:

"According to the study, active-share percentages are a good predictor of performance. Funds registering the highest active share beat their benchmark index by an average of 1.39 percentage points, while those in the lowest active share group produced returns that, on average, fell short of their benchmark by 1.41 percentage points. This makes sense, argues Mr. Petajisto, one of the study's authors. Once fees are subtracted, a fund hugging an index is going to be hard pressed to provide investors with returns that top the index.

"In addition, the study found that, in general, funds with higher active-share readings tend to repeat top performance. "It's consistent with the idea that the most active funds are likely to have more skilled managers," Mr. Petajisto says.

"...funds with active-share readings above 95% include managers with top long-term track records built through years of building eclectic portfolios. Among them are CGM Focus, Brandywine Blue Fund and Longleaf Partners funds."

Timothy Burger
timothyb(at)timothyburger.com