Active Share is a popular metric used to gauge how actively managed a portfolio is compared to its benchmark, but its predictive power for fund performance is questionable. Our research suggests that high Active Share often reflects exposure to systematic equity factors rather than genuine stock-picking skill. Additionally, inaccuracies in benchmark selection can distort the metric’s insights, making it unreliable as a standalone measure. A more effective approach is to conduct a factor analysis of alpha to better understand a manager’s performance and true sources of over/underperformance.

Cremers, Liu, B. Riley (Apr 2023) share their view on and try to answer the question: how well do factor investing funds perform? They conclude that, on average, factor-investing funds do not outperform. But using active characteristic share (ACS)—an adaption of Cremers and Petajisto’s (2009) original active share measure—, the authors demonstrate that the factor investing funds that match indexes the most have significantly better performance. An equal-weighted portfolio of factor investing funds in the lowest tercile of ACS outperforms an equal-weighted portfolio of funds in the highest tercile by 3.82% per year (t-stat = 3.89) using the CAPM and by 1.08% per year (t-stat = 2.01) using the CPZ6 model.

Environmental, social, and governance (ESG) investing is rapidly growing in popularity. As more investors grow interested in the ESG investing, the funds theoretically have more reason to highlight their engagement with the ESG-related activities. In the research paper by Andrikogiannopoulou et al. (2022), authors first use textual analysis to assess how and how much the funds talk about ESG-related topics in their prospectuses, and then they compare this measure with the funds’ actual ESG engagement. The discrepancy between the words in their prospectus (high rate of mentioning ESG investing-related topics) and the fund’s acts (not being as green as illustrated in the prospectus) allows the authors to identify the greenwashing funds and take a closer look at their performance.

Recent corona-crisis turbulence brought us many unexpected things, and one observation is connected with the fixed-income market. The conventional wisdom says that there is a flight to liquidity during troubled times and crises. Traditionally, liquid assets are US Treasuries or high-quality corporate bonds. Therefore, in theory, the pandemic should have been connected with buying pressure of high-quality liquid assets. However, as shown by a novel, insightful research from Ha, Xiao and Zeng, the exact opposite held. There was a very unusual sellout of liquid assets such as high quality fixed income as mutual funds tried to meet their redemption requests.

Authors: Yiming Ma, Kairong Xiao and Yao Zeng

Title: Mutual Fund Liquidity Transformation and Reverse Flight to Liquidity

Risk-averse investors want higher returns at any cost. If they are constrained and are not able to use leverage on their own, they will look for other ways to increase their performance. Recent academic paper written by Hitzemann, Sokolinski, Tai suggests, that such risk-seeking investor will search for a high-beta fund that will give them requested embedded leverage, even when that fund charge higher than average fees. Resultant net alpha of those high-beta funds is then negative, and this effect can explain the significant part of the underperformance of the overall mutual fund industry. And now, the logical question follows: As hedge funds have even higher fees than mutual funds, what is embedded in them, that constrained clients normally can’t access? Higher leverage and access to option-like return distribution? Maybe…

Authors: Hitzemann, Sokolinski, Tai

Title: Paying for Beta: Embedded Leverage and Asset Management Fees

Financial markets are full of pricing anomalies, and their existence is often explained by human behavior. Behavioral finance postulates that cognitive irrationality is manifested in biases like the disposition effect (the tendency of people to sell assets that have increased in value, but keeping assets that have dropped in value in portfolio) or overconfidence bias (the tendency of people to be more confident in their own abilities). There are some papers which directly link investment decision making caused by these biases to actual physiology of investors (for example, a known impact of testosterone on investment performance). A new research paper written by Nofsinger, Patterson, and Shank examines not only testosterone but also cortisol levels of testing subjects and then compares their performance in a mock investment contest. Both hormones are strongly related to higher portfolio turnover and inability to accept losses, with cortisol levels even more significant than testosterone.

Author: Nofsinger, Patterson, Shank

Title: On the Physiology of Investment Biases: The Role of Cortisol and Testosterone