Martijn Cremers Presentation

Patient Capital OutperformanceThe Investment Skill of High Active Share Managers Who Trade Infrequently

Martijn Cremers
University of Notre Dame

Ankur Pareek
Rutgers Business School

Overview

1.Active management
–Active Share: Difference in holdings
–Historical Active Shares, by fund type and size
–Active Share and performance (updated and by style)

2.Patience: a rare skill?
–Fund Duration
–Active Share, patience and performance in 3 samples:
–Retail Mutual Funds (net returns)
-Aggregate Institutional Long-only Equity Holdings (13F)
-Aggregate Hedge Fund Long-only Equity Holdings (13F)

3.Conclusion

‘Active’ means ‘Different’

-Investorsface basic choice between
i)Actively managed funds
ii)Passive benchmark (index fund or ETF)

-What does ‘active’ mean?
-Basic definition: ‘active’ means different
-Outper formance only possible if fund is different
-and fees not too large relative to overlap

-How do we measure this?

Alternative Active Share formula

What is a ‘low’ Active Share?

-How many people can be ‘above average’?
–What percentage of benchmark assets can beatthe benchmark?

-Logic: exactly half the holdings
–Active funds: Active Share (clearly) above 50%

-Benchmark-specific: S&P 500 versus Russell 2000
–100 randomstocks from S&P 500, value-weight
–Result: Active Share of about 80%
–100 random stocks from Russell 2000: Active Share of 95%
–Benchmark concentration / # of stocks / liquidity / etc.

Cremers –Petajisto 2009 study

(data in study starts in 1990 and ended in 2003, updated to 2013 here)

For all actively managed all-equity retail mutual funds:

-Calculate Active Share at the end of this year
-Assign benchmark
–Based on self-declared benchmark if available
–Otherwise assigned based on holdings overlap
-Calculate fund’s net returns
–Over the next 12 months
–Benchmark-adjusted: deduct benchmark return
–Net: after deducting all fees & trading costs (except loads)
-Repeat everything at the end of next year

Why would Active Share relate to future performance?

-Successful managers need
–Skill, guts and opportunity
–Don’t need skill to have a high Active Share
-Do need guts and opportunity
-Suppose: I have a lot of guts and opportunity
–But no skill…: How long would I survive?
-Skill: hard to measure, attracts flows and is expensive
-Is skill scalable? Time-varying? Transferable? Rare?
-What is a rare skill?

Rare skill: patience?

(with high Active Share)

-Fund Duration
–average length of time an average dollar in the portfolio has been in the portfolio (in the last 5 years)
-Robustness: turnover & holdings-turnover
-3 samples:
1.retail mutual funds –net returns
2.all institutional portfolios (13Fs) –quarterly holdings
3.hedge funds (13Fs) —(long-only) quarterly holdings

Results robust to…

-Alternative patience proxies
–turnover (mutual funds)
–holdings-based turnover (for institutions and hedge funds)
-Controlling for flows / size / year f.e. / etc.
–In pooled panel regressions
-Controlling for longer-time changes in turnover
-BaB(Betting against Beta) and QmJ(Quality minus Junk)
–Cannot explain results for institutions & hedge funds

Conclusion

-Active Share

–Low Active Share funds: tended to underperform
–High Active Share funds: tended to outperform
-Large cap: high Active Share did not underperform
-Small cap: high Active Share outperformed
-Patient funds with high Active Share outperformed

–Mutual funds
–Institutions (holdings-based, long-only, 13Fs)
–Hedge funds (holdings-based, long-only, 13Fs)
-Impatient funds (had holdings which) underperformed
–Low Active Share funds: More underperformance with more frequent trading

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