Deconstructing Active Share: Why Do High Active Share Funds Outperform?

Abstract

We deconstruct the active share measure proposed by Cremers and Petajisto (2009) and find two-thirds of the outperformance of high active share mutual funds can be attributed to the ability of those funds to select out-of-benchmark stocks. However, that ability is limited to high active share funds that use out-of-benchmark positions sparingly. Funds with large out-of-benchmark positions show little ability to select out-of-benchmark stocks. Our results suggest that the best active funds generally stay within their benchmark, deviating only for particularly good purchases, and that conditioning on the amount of out-of-benchmark investing significantly increases the predictive power of active share.