There are (at least) two distinct ways of measuring the extent to which a manager attempts to create value.  One is returns-based (alpha, tracking error, information ratio etc.) and one is holdings-based (the delta between holding weights and index weights).  Holdings-based measures can provide a discrete snap-shot of a manager’s “activeness” which seems objective and undeniable.  After all, if a manager holds positions in wildly different proportions that those in the index, how can his fund be anything other than highly active?

Unfortunately, things may not be that simple.  A manager can pursue a passive strategy using a concentrated, yet representative sample of index names.  Thus, security weightings would differ from index weightings, but the fund would perform very much like the market.

Similarly, a fund can have security weightings that are similar to those of the index when the market is rising and different when the market is falling.  Catch the fund at the wrong time and it would look passive.

Mustafa Sagun and Scott Leiberton of Principal Global Investors make the case for adding holdings-based analysis to traditional measures of “activeness” in this December 2007 paper (”Alpha Dynamics: Evaluating the Activeness of Equity Portfolios“).  Say the duo:

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