Contrast Active Share with active risk and relate each measure to the strategy a manager follows
The idea
Active Share measures how far holdings differ from the benchmark: Active Share = ½ × Σ |portfolio weight − benchmark weight|, ranging from 0 for an index copy to 1 for no overlap. Active risk (tracking error) is the standard deviation of excess returns and depends on how correlated the active bets are. A diversified stock picker with many small, unrelated bets has high Active Share but modest active risk. A factor or sector bettor who holds index-like stocks within big sector tilts has lower Active Share but high active risk. Concentrated stock pickers are high on both; closet indexers are low on both. The trap is treating either measure as a full description of how active a manager is.
Formulas
Active share
Active Share = ½ × Σ |portfolio weight − benchmark weight|
- portfolio weight
- each security's weight in the portfolio
- benchmark weight
- its weight in the benchmark
- Σ
- the sum over every security held by either
0 is the index itself and 1 shares nothing with it. Read it with active risk: high active share with low tracking error is diversified stock picking, low active share with high tracking error is concentrated factor bets.
In the app: 2 practice questions on this outcome, a narrated walkthrough with diagrams, spaced review that brings it back before you forget it.
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