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Active Share for Foreign Funds Morningstar Research | Kevin McDevitt

We calculated their active share based on their most recent portfolio and relative to the analyst-selected benchmark for their respective category. What stood out is how closely the results align, at least anecdot- ally, with what we’ve seen so far among actively managed U.S. stock funds. In fact, some of the most active foreign-stock funds share DNA with some of the bolder U.S. stock funds. This certainly applies to foreign large-blend fund Longleaf Partners International LLINX . It tied with foreign large-blend Janus Overseas JAOSX for our group’s highest active share, 98 . 5% . This is similar to the results for large-blend sibling Longleaf Partners LLPFX , which has one of its category’s highest active shares relative to the S & P 500 Index, 96 . 0% . Such lofty differentiation owes to both funds’ extremely concentrated portfolios. Each holds just 20 stocks or so, with more than 50% of assets in the top- 10 holdings alone. For Longleaf Partners Interna- tional, this includes insurance company Fairfax Financial Holdings FFH , which is run by Warren Buffett acolyte Prem Watsa. One other trait the siblings share is high tracking error. Tracking error measures the volatility of a fund that is not explained by movements in the benchmark. Whereas active share notes differences with the benchmark at the individual position level, tracking error measures so-called factor bets, such as over- weighting a given sector relative to the index or hold- ing lots of cash. As a general principle, highly con- centrated funds tend to have both high active share and high tracking error. With 25% currently in cash and a nearly 40% position in industrials, Longleaf Partners International illustrates both. Such bets give the fund a fairly high five-year tracking error of 7 . 4% relative to our group’s 5 . 5% median. But that’s not high enough to place among the group’s boldest players. That distinction belongs to Janus Overseas, with a 13 . 7% five-year tracking error, and First Eagle Overseas ’ SGOVX 10 . 2% . With more than 100 holdings, First Eagle isn’t nearly as concen- trated as Longleaf, but its portfolio is just as eclectic.

Active share among U.S. equity funds has received a lot of attention since Martijn Cremers and Antti Petajisto published their first paper on the topic in 2009 . Their work quantified the degree to which managers differentiate their funds from their bench- marks, as active share measures the percentage of a fund’s holdings that differ from the benchmark’s weightings. This made it easier for investors to spot closet indexers who charge active-management fees. Cremers and Petajisto’s research also found that sufficiently high active share is perhaps a necessary— but not necessarily sufficient—precondition for outperformance. Our tests have not found a link with outperformance. Yet, actively managed foreign-stock funds have so far escaped this scrutiny. That’s partly because foreign- equity data isn’t as reliable as domestic-stock data. Because of the existence of multiple share classes for many multinational companies, active share is likely overstated to a small extent for many foreign- stock funds. Take consumer staples giant Unilever . Its shares trade as ADR s in the United States, as well as in the Netherlands and in London. If the share class held in a fund portfolio doesn’t match the one represented in the index, the stock may count as an active position relative to the benchmark. This issue likely will be corrected as foreign-stock databases become more robust. For the time being, though, we’re treating this as a first look at foreign- equity active share, sticking to broad themes with details to be filled in later. Common Traits With U.S. Cousins As an initial inquiry, we looked at the actively man- aged large-cap foreign-stock funds in the Morningstar 500 . This group includes 31 funds, with just more than half of them in the foreign large-blend category.