EMH is easily disproved, of course, if only by exception. In the year to 9 February 2016 the FTSE100 index fell by more than 17%. However, deeper analysis tells us that the 20 best performers rose in price by over 15%, while the 20 worst fell by over 42%. In other words, there was a distribution of possible returns of almost 60%, from only 100 securities.
There is a universe of 2365 securities listed on the London Stock Exchange, presenting boundless possibilities for stock-selectors to capture excess returns. The largest 641 of those constitute the FTSE All Share Index, representing 98% by weight of all the investable securities. £100 invested in that index would be worth less than £85 in capital terms over the year to February 8th 2016. Passive investors in the UK market have suffered accordingly.
However, the average active UK All Companies fund, which has to invest at least 80% of its assets in the UK market, would be worth more than £92. The chart shows the relative return active management, and the UK’s top 100 companies, have made relative to the All Share Index. The story is repeated in global equity markets, in local currency.
Now that’s a small sample. The real problem is that many active managers are not particularly active – too many look too much like the index they purport to outperform, – delivering tracker performance at ten times the passive charge. This is indefensible.
However there are managers who are giving their investors a ‘return to selectivity’, as Eugene Fama, the Godfather of index-tracking himself describes it. “Active Share” is a measure of the percentage weight of each security in a fund, relative to its weight in the benchmark index. A passive fund would have an active share of near zero, while the maximum measure of activity would be 100%. If we combine active share with tracking error (the standard deviation of the difference in the portfolio and benchmark returns over time), we can analyse the constituents of fund sectors to see whose process is simply passive in disguise, and who is genuinely performing a service of benefit to investors.
It’s time managers broadcast their active share, so we can see which active managers ‘pretend’ to be active, allowing us to select them out, and uncover the true deliverers of alpha.
