ANALYSIS DECEMBER 2016

ACTIVE SHARE
IN AFRICA
By Guy Antoine, Senior Investment Analyst, Sustainable Capital

L
isted equity markets in Africa (excluding South Africa) present an
opportune environment to add investment-alpha (fund returns exceeding
the benchmark’s returns). Public disclosures are minimal compared with
developed markets, and the research burden of on-site due-diligence is high. These
factors lead to relatively inefficient markets, which can be exploited by a skillful
manager willing to invest the time and resources required to uncover mispricing
opportunities.
Active Share is a useful tool to
FIGURE 1: ACTIVE SHARE FOR THE SUSTAINABLE CAPITAL AFRICA ALPHA FUND
identify managers that are pursu-
ing benchmark-agnostic strategies.
100
It measures the degree to which a
portfolio differs from its benchmark.
The range of possible values is from 90

0% for a passive portfolio tracking

its benchmark exactly, to 100% for an
Active Share, %

80
active portfolio that is constructed
entirely of off-benchmark assets.
What makes Active Share appealing 70

is its simple calculation and intuitive

interpretation. Figure 1 shows Active
60
Share for the Sustainable Capital Africa
Alpha Fund. The fund’s Active Share
has averaged 83% since inception. 50
1-Jan-12 1-Jan-13 1-Jan-14 1-Jan-15 1-Jan-16
Funds having an Active Share of 60% or
lower are commonly labeled “Closet In- "Closet Indexers" Sustainable Capital Alpha Fund Average
dexers” (funds that market themselves
as active managers, but tend to track
the benchmark relatively closely).
A simple example best illustrates the calculation of Active Share. Table 1 shows two
hypothetical, 5-stock portfolios, each with different benchmarks. Portfolio A has a
high deviation from the benchmark with an active share of 90%. Portfolio B resem-
bles the benchmark more closely with an active share of 20%.
By combining Active Share with Tracking Error 1, one can identify different styles
of active management. Figure 2 is a matrix dividing the universe of active managers
into the following quadrants based on Active Share and Tracking error:

• Diversified stock pickers who take large but diversified positions away from
the index.
• Concentrated stock pickers who combine very active stock selection with
exposure to systematic risk.
• Factor Bets (top-down sector or style driven strategies) who generate large
volatility with respect to the index even with relatively small active positions.
• Closet indexers who do not engage much in either type of active manage-
ment.
1
Tracking Error is another widely-used measure of active management. Defined as stdev(Returnfund -
Returnindex ), it emphasizes correlated active bets.

12 | www.africaglobalfunds.com
ANALYSIS DECEMBER 2016

TABLE 1: ACTIVE SHARE CALCULATION

Benchmark A Portfolio A Abs (Portfolio-Benchmark) Benchmark B Portfolio B Abs (Portfolio-Benchmark)
Stock A 35 0 35 Stock A 30 20 10
Stock B 30 0 30 Stock B 30 20 10
Stock C 25 0 25 Stock C 20 20 0
Stock D 5 50 45 Stock D 10 20 10
Stock E 5 50 45 Stock E 10 20 10
Active Share = 0.5 x Total of Column = 90 Active Share = 0.5 x Total of Column = 20

Consistent with Sustainable Capital’s investment approach, the by emphasizing positions having a smaller weight in the bench-
Alpha Fund falls into the ‘Concentrated Stock Picker’ category. mark (Stocks D & E in our example).
We aim to construct a concentrated portfolio of high conviction This principle has important implications for fund size. Asset
ideas based on detailed due diligence. This process results in high managers with lower assets under management can take larger
Active Share and high Tracking Error. positions in the less liquid stocks that make up the benchmark.
This allows for more active management, and the ability of the
FIGURE 2: AVERAGE FUND PERFORMANCE BY MANAGER STYLE
Annualised Alpha gross | net (of fees and expenses), percent manager to deploy their skill effectively. Larger funds are con-
strained, being forced to construct portfolios that more closely re-
Active Tracking error quintile
semble the benchmark. This is especially relevant in Africa, where
Share Low 2 3 4 High
liquidity is constrained and market penetration is low.
High Empirical research (Cremers & Petajisto 2009) suggests that com-
1.6 | 0.3 2.3 | 1.3
bining high active management with smaller fund size uncovers
4 Diversified Stock Picks Concentrated Stock Picks
the best performing group of managers. Figure 3 presents perfor-
3
mance for funds with high Active Share, separated by fund size.
0.3 | -1.2 0.5 | -1.2
2
Closet Factor
Low Indexing Bets FIGURE 3: PERFORMANCE BY FUND SIZE FOR HIGH ACTIVE SHARE
MANAGERS
Source: Cremers & Petajisto 2009 (data), Sustainable Capital analysis Annualised alpha net of fees and expenses
Small Large
The research presented below indicates a positive correlation Fund Fund
between high Active Share and investment performance. Figure Size 2 3 4 Size
2 describes average fund performance for a sample of 2,647 US 1.7
based mutual funds over the period from 1980 to 2003. In aggre- 1.4
Alpha (net of fees), percent

gate, funds with high Active Share outperformed their benchmarks 1.2

net of fees. This finding has attracted some criticism because it

conflicts with popular research promoting the use of low-cost,
passive index trackers.
The conflict can be explained by ‘Closet Indexers’ who drag down
the performance of active funds as a whole. This makes intuitive
sense: How can one create significant alpha without taking signif-
icant off-benchmark bets? By charging active manager fees, this
strategy is doomed to fail.
COMPARING ACTIVE SHARES
When comparing Active Shares, the choice of benchmark is impor-
tant. A benchmark that fails to accurately represent the invest-
ment opportunity set will naturally inflate a manager’s Active
Share. At the inception of Sustainable Capital, no relevant bench-
marks for Africa (ex South Africa) existed, making it difficult to
measure manager skill. This prompted us to commission Standard
& Poors to create the S&P Pan-Africa (ex SA) capped index.
The concentration of member weights in an index is also impor-
tant. The S&P Pan-Africa (ex SA) index is concentrated with the Top
10 constituents comprising 35% of the index compared to 15% for
the S&P500. Referring to our simple example, Portfolio A’s bench-
mark has a high concentration with its top 3 weights accounting
for 90% of the benchmark. A manager achieves high Active Share
0.2
-0.7
Source: Data from Cremers & Petajisto 2009. Sample takes funds from the highest active
share quintile.
The issue of fund size is particularly significant in Africa ex-SA
where the overall market is down 37% since mid-2014. The conse-
quent low valuations further reduce liquidity, giving smaller funds
the ability to better navigate bear markets. With liquidity in Africa
ex-SA at a cyclical trough, our analysis reveals that Active Share is
likely to decline materially at fund sizes over $500m.
In conclusion, the nature of the African (ex-SA) markets are con-
ducive to active management. By using Active Share and Tracking
Error, one can differentiate Concentrated Stock Pickers from other
strategies. This type of active management appears to deliver su-
perior long-term returns. Smaller fund size enhances a manager’s
ability to outperform through skill, an important consideration in
Africa where liquidity is constrained.

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