Morningstar, Inc. (NASDAQ: MORN), a leading provider of independent investment research, today published a research report, “Active Share in European Equity Funds.” The analysis reveals that 20 percent of the funds examined qualify as closet indexers, which are actively managed funds that largely mimic their benchmark while charging active management fees. However, the proportion of funds in the analysed categories that can be characterized as closet indexers has been falling in recent years. Active share quantifies how much of an equity portfolio's holdings differ from its benchmark. A portfolio with an active share score of 100 percent would have no common holdings with its category’s index while a portfolio with an active share of 0 percent would be identical to its benchmark. The higher the score, the more actively the fund is managed.
Authored by Senior Manager Research Analysts Mathieu Caquineau, Matias Möttölä, and Jeffrey Schumacher, the research report examines how active share has developed over a 10-year period, from 2005 to 2015, for the Morningstar Categories Europe Large-Cap Value Equity, Europe Large-Cap Blend Equity, and Europe Large-Cap Growth Equity, consisting of European large-cap funds investing in European equities, and encompassing 456 offerings. It is a comprehensive report that examines active share in Europe from many perspectives, including historical changes in active share, the relationship between active share and performance and active share and risk, and the role of active share in fund selection. The study is based on proprietary holdings data for European funds collected by Morningstar since the early 2000s.
“Although we identified one in five European equity funds as a closet indexers, our research shows that the proportion of closet indexers has been shrinking,” Möttölä said. “Average active share levels dropped considerably during the financial crisis of 2008 and 2009 but have been rising at a steady pace since then. In Europe we’ve witnessed increasing scrutiny from regulators in many countries, which could lead to structural change and less closet indexing in the market.”
Möttölä added, “Investors who use active share as a fund selection tool should exercise caution. As active share increases, dispersion in returns and risk levels rises sharply, with both the best- and worst-performing funds found among the more active funds. It is the portfolio managers’ skill in selecting the right deviations from the index that generates outperformance. Among the least active funds, we found that almost all closet indexers underperformed their benchmark. If combined with high fees, such a fund is rarely a good choice. Investors should compare fees carefully as funds with similar active shares can have fees that differ greatly. We believe active share is best used only in combination with other quantitative and qualitative tools.”
Additional key findings of the research report include: