"Since the early 1990s, in order not to end up in the fourth quartile in performance, many managers have increasingly just mimicked their index or benchmark," writes McCarthy in his new book The Safe Investor. "They do this because they don't want to risk performing substantially worse than their index and then be fired."
The fact that the industry standards make it possible for everyone who calls themselves actively managed to charge 1 percent or 2 percent means that a manager can embrace mediocrity and still be highly paid.
The flip of the closet indexers, of course, are the funds that are truly actively managed. In somewhat controversial research, Cremers found that those funds that differed from their benchmarks by more than 80 percent had a much better chance of outperforming, and did so by an average of 1 percent, net of fees, over 20 years. (Vanguard has published a white paper that found active share did not make a difference in performance).
Only a handful of mutual funds differ from their benchmarks enough to have a high active share and to be considered by experts to be truly actively managed. Cremers said for large cap funds, only about 12 percent of the assets in retail mutual funds is in funds with an active share above 80 percent, meaning that their assets differ by 80 percent from their benchmark. For small cap funds, about 30 percent of assets in retail mutual funds is in funds with an Active Share above 90 percent, and about 72 percent is in funds with an Active Share above 80 percent.
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Active share may be the most conceptually sound support for active management that has come around in decades. Morningstar has already said it plans to add it to the information it offers about mutual funds.
However, active share also in a way narrows the case for active management. It is just much easier to make money by investing in strategies that aim to keep fees low and match the benchmark than it is to make a good bet on a fund that is truly actively managed, which takes a lot of research.
"I would say that unless you know that a fund is truly active, I would be really hesitant," Cremers said. "If you do have time, and you're interested in digging deeper, there's a lot to learn and I think active share can help."