Why direct engagement makes a difference

Investors pay extra fees for active management. As a result, they’re likely to feel disappointed – if not thoroughly deceived – if they find an actively managed fund conspicuously mirrors its benchmark.

The debate over how much a portfolio should differ from its underlying index in order to avoid accusations of “tracking” has been raging for years. It’s now two decades since some kind of answer first began to emerge, courtesy of a pair of finance professors at Yale University.

Published in 2006, Martijn Cremers and Antti Petajisto’s groundbreaking research coined the term “active share”. This describes the proportion of a portfolio’s holdings that deviate from its benchmark index.

A pure index fund has an active share of 0%, while a fund that has zero overlap with its benchmark has an active share of 100%. Cremers and Petajisto proposed that funds with an active share of between 20% and 60% should be classed as what are now commonly branded “closet trackers”.

Aberdeen Asia Focus generally has an active share in the upper 90s relative to the MSCI AC Asia ex Japan Small Cap Index, reflecting a high degree of deviation from the benchmark rather than any indication of reduced investment risk.

The explanation for this is simple enough: the fundamental purpose of deviating from a benchmark is to outperform it. In other words, we don’t want to be the market – we want to beat it. But does a fund like ours hope to outperform merely on the strength of being contrarian or is there a more rigorous approach at play here?

The importance of digging deeper

I hope you won’t be too surprised to learn that, at least as far as we’re concerned, the latter is the case. In our opinion, a high active share is a consequence of informed stock-picking – and informed stock-picking, in turn, is in large part a consequence of direct engagement.

Particularly in a market like Asia, many investment teams prefer to observe from a distance. They often rely on quantitative data and the work of third-party analysts to identify companies worthy of inclusion in portfolios.

It’s right to say this can succeed. It’s perfectly possible for investors to earn an acceptable return from a passively managed, quant-driven index fund.

Yet it could be argued that numbers alone might not tell the whole story. For instance, an apparently impressive financial statement might conceal the weaknesses of a business that has done well over the short term but has no meaningful plan for the way ahead.

In addition, many of Asia’s smaller companies – the arena in which we invest – attract no third-party analysis in the first place. There might be an abundance of numbers out there, but it doesn’t automatically follow that someone will obligingly crunch them.

This is why an on-the-ground presence can deliver such valuable insight. In our view, “being there” – genuinely getting to grips with places, people, policies and practices – is vital to identifying unrecognised opportunities in some of the world’s most exciting economies.

The hunt for hidden gems

So what exactly do we hope to learn when we carry out site visits and conduct face-to-face discussions with senior managers in Asia? Ultimately, we’re looking for compelling evidence that a company is capable of long-term growth.

Again, especially in an era when disclosure pressures are mounting and AI is transforming how information is gathered and processed. you might think a raft of readily available data should tell the tale. Sure enough, it can play a significant role.

Yet it’s almost always instructive to get a first-hand look “backstage”. In our experience, discovering whether the image a business projects is an accurate reflection of what’s going on behind the scenes can be extremely useful.

Maybe above all, in-person dialogue is tough to beat. Meeting with executives and asking them questions – some straightforward, some awkward – is one of the most powerful means of establishing whether a company truly has a strategic vision for the future.

It’s important to note that active share can be “gamed”. It’s sometimes cited as a classic example of Goodhart’s Law – named after economist Charles Goodhart, who posited that a measure stops being useful when it becomes a target. However, this is likely to occur only if managers select off-benchmark stocks purely so they can present investors with an eye-catching active share percentage.

That’s not how we do things. Our commitment to direct engagement underlines our determination to be genuinely different – not just for the sake of it but because we firmly believe there’s real merit in seeking out Asia’s hidden gems.

Other important information:

Issued by abrdn Fund Managers Limited, registered in England and Wales (740118) at 280 Bishopsgate, London EC2M 4AG. The company is authorised and regulated by the Financial Conduct Authority in the UK.

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