Higher active share metric differentiates RI funds

July 30, 2019

There are many reasons to invest in responsible funds. First, responsible funds hold companies that are making the world a better place, solving some of the world’s biggest challenges, and have a long-term sustainable approach to the way they operate. All desirable characteristics in a company. Then there are the benefits to your portfolio. Because these companies generally have a long-term focus, they tend to measure well in the long-term risk metrics, providing sustainable growth and reducing the risk of a catastrophic event.

There’s yet another reason to buy a responsible fund: There is a different set of criteria (ESG guidelines) overlaying the investment decisions, and that results in a portfolio that should provide some diversification and some differentiation from the market. But how different are they? To answer this question, I thought I would dig into some active share numbers.

“Active share” is a calculation that shows the degree to which portfolio holdings differ from a benchmark’s constituents. The higher the active share, the more different a fund is from the benchmark. It is often used to identify “closet index” funds, that is, funds that are branded as actively managed but really just track an index.

Closet index funds have been identified by researchers Martijn Cremers and Quinn Curtis as those with an active share under 60%.* Active share is also useful in identifying funds that could potentially outperform, as research has shown that funds with high active share tend to outperform their peers, and can be used (when combined with other metrics) to determine whether the you are paying an appropriate MER for a fund.

When you buy a responsible fund, or any fund for that matter, you are paying a professional money manager to make the investment decisions for you. You are paying for the active management, so a high active share is desirable. You do not want to be told you are buying a responsible fund only to find out you are essentially holding the S&P/TSX Composite Index, for example.

For this analysis, I looked at mutual funds and ETFs from three of the most relevant categories defined by the Canadian Investment Funds Standards Committee (CIFSC): Canadian Equity; U.S. Equity; and Global Equity. I took out index-tracking funds, unless the index they are tracking is significantly different from the category index. For example, in the Canadian Equity category I left in the funds that track the Jantzi Social Index for obvious reasons. The benchmarks used for each category are shown in the accompanying table.

Now let’s get into the results. The biggest takeaway from the accompanying graph is that the RI funds in each category produce more active share on average than the non-RI funds.

Canadian Equity. Canadian Equity produces the lowest active share numbers by far. This is not especially surprising when you consider the S&P/TSX Composite Index has 239 constituents. There are only so many Canadian companies to invest in, so any mutual fund or ETF is bound to have some overlap with the index. Compare that with the 500 companies in the S&P 500 Composite Index and the 1,655 companies in the MSCI World Index and the low active share numbers make sense.

The RI funds have 6% more active share than the non-RI funds, with the NEI Canadian Equity Fund leading the way at 69%. An interesting note here is that the two funds that track the Jantzi Social Index, iShares Jantzi Social Index ETF (TSX: XEN) and NEI Jantzi Social Index Fund, have active share numbers of 59% and 58% respectively. According to researchers Cremers and Curtis, that is in the closet index range. Again, I’d say that is more a reflection of the limitations of the Canadian Equity market as opposed to the intent of the Jantzi index.

U.S. Equity. This category shows better active share overall, with the RI funds achieving 4% more active share than the non-RI funds. The top RI fund is the Desjardins SocieTerra American Equity Fund at 80% with the NEI U.S. Equity Fund coming in at 74%.

Global Equity. This category has the highest active share numbers overall, again not surprising when you consider the size of the investment universe. The RI funds are producing only percentage point more active share than the non-RI funds, but very impressive in absolute terms, averaging 88%. The top RI fund is the AGF Global Sustainable Growth Equity Fund at 98%, while the Desjardins SocieTerra Environment Fund comes in at 89% active share.

It is clear from the numbers that on average, RI funds do produce more active share than non-RI funds. Which leads to the conclusion that most RI funds are in fact giving you a portfolio that is different enough from a typical equity fund.

* Cremers, K. J. Martijn and Curtis, Quinn, “Do Mutual Fund Investors Get What They Pay For? The Legal Consequences of Closet Index Funds” (November 24, 2015).

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