Patient Capital Outperformance: The Investment Skill of High Active Share
Managers Who Trade Infrequently (Digest Summary)
Journal of Financial Economics
Among equity mutual funds and institutional portfolios whose positions are highly
differentiated from their benchmarks, funds with longer holding periods outperform their
benchmarks by an average of 2.05% a year. This outperformance is mostly attributable to
fund managers who not only focus on low-beta, high-book-to-market, and high-credit-quality
stocks but also stick to their convictions over relatively long periods.
How Is This Research Useful to Practitioners?
Prior literature has shown that the long-term net performance of active managers is roughly
similar to or worse than that of benchmark returns, on average. The authors, however, find
that Active Share, or the degree of difference between a fund’s holdings and its
benchmark’s holdings, and the duration of fund holdings are important factors in
determining ex ante the outperformance of both mutual funds and
Among high Active Share mutual funds, those with patient investment strategies (holding
durations of more than two years) appear to outperform their benchmarks by an average of
2.05% a year under the five-factor model used in the study.
At the other end of the spectrum, irrespective of how dissimilar their portfolios are
relative to their benchmarks, highly traded mutual funds with short durations underperform,
with average annual five-factor net returns of negative 1.44%.
The authors investigate the skill level of high Active Share and long-duration fund
managers by measuring their exposures to seven factors: market, size, book-to-market ratio,
momentum, systematic liquidity, low versus high beta (using the “betting against
beta” factor, which is a long–short portfolio in low-/high-beta stocks), and
earnings quality (using the “quality minus junk” factor, which is long
profitable, growing, higher-payout stocks and short the opposite). The authors find that the
last two factors explain the outperformance of high Active Share patient managers of both
mutual funds and institutional portfolios.
How Did the Authors Conduct This Research?
The authors look at two samples: (1) actively managed all-equity US retail mutual funds
from the CRSP survivorship-bias-free mutual fund database and (2) institutional investor
equity portfolios inferred from quarterly Form 13F statements.
For both samples, the authors conduct 5 × 5 independent double sorts into holding
duration quintiles and Active Share quintiles. Performances are compared along both
dimensions. Mutual fund performance is examined over the 1990–2013 period with respect
to net returns and holdings-based gross returns. Institutional fund performance is analyzed
over the 1984–2012 period with respect to holdings-based gross returns only, because
of the nonobservability of after-fee returns on their short positions.
Active Share measures the proportion of a fund’s equity holdings that are different
from the holdings of the fund’s benchmark at a particular point in time.
Fund duration, fund holdings turnover, and the self-declared turnover ratio are the three
proxies the authors use to determine how long funds hold stocks in portfolios.
The authors evaluate net mutual fund performance using a five-factor model (market, size,
value, momentum, and liquidity) and an index-based seven-factor model (tradable benchmark
indexes for one market, two size, and three value factors, as well as a momentum factor).
For both mutual funds and institutional portfolios, the authors evaluate holdings-based
gross returns while controlling for size, book-to-market value, and momentum
The authors debunk the popular notion that over long periods, both mutual fund performance
and institutional fund performance approximate the benchmark. For this research, however,
they focus solely on US equities. The dynamics of equity markets in different countries
differ from the dynamics of the US market in terms of the periodicity of performance
measurements, the liquidity depth of benchmarks and stock holdings, and the difference in
arbitrage opportunities. It would be interesting if researchers were to use the
authors’ findings to look at how different market conditions across countries could
affect the excess returns of high Active Share portfolios that follow patient investment
Today, when most investors avoid systemic risk from overinvesting in one asset class, a
study on how the interaction of Active Share and trading frequency affects different asset
classes in the same fund could yield important insights into how investors might best earn
excess returns while reducing risk via the diversification of asset classes.
About the Author(s)