six-year performance window that is more consistent with
investor holding periods, we find a positive and significant
relationship between active share and fund performance.
More-active funds significantly outperform less-active funds.
Indeed, we find that about 70 percent of the actively managed
funds outperform the benchmark index exchange-traded fund
depending upon the performance metric used.
We also find compelling evidence that funds that alter their
active share over time (as proxied by the standard deviation of
active share) have significantly worse performance. However,
this effect seems to be mostly in funds that are highly active.
Funds that are not as active do not seem to suffer as much in
performance if they vary the level of activeness over time.
Our result that consistency of activeness is positively related
to fund performance is similar to that found in Cremers and
Pareek (2016), i.e., that manager conviction—the ability to buy
and hold a consistently active portfolio—is a strong predictor of
fund performance. Intuitively these results also make sense.
If managers have the ability to outperform, why wouldn’t they
want to exercise this ability by having a consistently active portfolio? One can theorize that managers who lack conviction in
their ability to outperform are probably more likely to change
the level of activeness and therefore perform more poorly.
Finally our findings are broadly similar to the investment
approaches of superior investors such as Peter Lynch and
Warren Buffett: Buy companies that you like and hold them
for very long periods. Trying to time the market is difficult if
not impossible, and instead managers should buy and hold
portfolios that they believe in.
We also find, similar to much of the mutual fund literature,
that expenses matter. In every regression we run, expenses
are negatively and significantly related to performance.
Finally, we find that closet indexing in diversified emerging
market funds is present. On average about 16 percent of the
actively managed funds are closet indexing over our sample
period. These funds charge fees that are much greater than
true index fund fees. On a positive note, we find that during
2009–2014, closet indexing in diversified emerging market
funds seems to have decreased.
We believe our results are meaningful to prospective investors.
Our results indicate that emerging market equity funds that are
consistently highly active have significantly better performance
than other emerging market equity funds. Because active share
data are now readily available on Morningstar and other major
providers, investors can easily find these data for themselves
and thus make, we believe, better decisions about which funds
may outperform in the future. And if nothing else, by investors
and advisors examining active share, they can better avoid
active funds that are closet indexing.
Such closet indexing is particularly problematic for investors
because of the high fees associated with emerging market
funds. Investors in these funds pay significantly more than
an emerging markets equity index and yet receive similar
This trend toward less closet indexing is consistent with
Cremers et al. (2016), which finds a general reduction in closet
indexing for all funds over the time period 2008–2010.12
As noted earlier, Cremers et al. (2016) does not specifically
focus on emerging market funds, and our paper is the first to
specifically and solely focus on emerging market funds.
Emerging equity markets should offer some of the best opportunities for active managers because these markets are subject
to greater political and economic risk than developed markets.
Because of this relative market inefficiency, a skilled investor
that has access to local information should be able to consistently outperform a non-informed, passive investor in these
markets. Yet, until now, there has been only mixed evidence
that active fund managers outperform in these markets.
In this paper we re-examine the link between active management and fund performance in diversified emerging market
equity funds by using active share, a measure that identifies
how active a fund is compared to its benchmark index. This
is the first known use of active share to specifically and solely
examine the performance of emerging market equity funds.
Using a sample that is robust to the prospectus benchmark,
different performance metrics and survivorship bias, and a
CLOSET INDEXING IN DIVERSIFIED EMERGING
For each quarter from 2009–2014, we take all the diversified
emerging market funds in the Morningstar database with
the MSCI Emerging Markets Index as the prospectus benchmark. For each quarter, we calculate the percentage of funds
that had an active share of 60 percent or less (solid line) or
70 percent or less (dotted line).
60 or Under 70 or Under