What Qualities Are Important When Choosing an Active Asset Manager?
While Active Share can be a helpful measurement for investors looking for equity funds with alpha generating potential1, it is not designed to evaluate the performance or skills of individual portfolio managers who employ active management strategies. Active Share may be one consideration used in a selection process for choosing actively managed mutual funds, but Touchstone has developed a more comprehensive framework which includes five factors that we believe can help determine the quality of active management: Skill, Conviction, Opportunity, Patience, and Expenses, or SCOPE.
In addition to having expertise in their respective asset classes, Touchstone believes active managers should exhibit skill at selecting investments, maintain tenured and credentialed staff and show the consistency of results over the life of the strategy.
Furthermore, Touchstone believes they should demonstrate conviction by having confidence in the companies in which they are invested and maintaining discipline and commitment to their investment approach over time. Conviction can be measured by the total number of holdings in combination with the concentration of stocks among the top holdings. For example, a more concentrated active manager may target 30 to 40 companies rather than investing across hundreds of stocks.
According to Martijn Cremers, PhD, opportunity is equal to a "relative lack of constraints—whether planned or client-enforced". Examples of these types of constraints include; position size, industry/sector exposure, capitalization, geographic region and tracking error.2 An actively managed fund with a high Active Share suggests a relative lack of constraints and thus the flexibility to implement a highly differentiated strategy.
Patience involves an active manager staying the course and buying companies rather than trading stocks. Finally, it’s important to understand expenses—the cost for active investing. This includes understanding not only the fund’s net expense but also the Active Fee which is the cost of the active portion of the portfolio; because the active portion of the portfolio is the only portion that can possibly outperform the benchmark.
1 Alpha is the portion of a fund’s total return that is unique to that fund and is independent of movements in the benchmark.
2 Tracking error is the difference between a portfolio's returns and its benchmark.