We could be asking the wrong questions about active versus passive management, a researcher says.

While most active funds fail to outperform their benchmark indexes over the long term, research from Martijn Cremers, the Bernard J. Hank professor of finance at the University of Notre Dame, has found that the more actively managed a mutual fund, the more likely it is to outperform.

“If you buy an active product, you pay a much higher fee, so you want to make sure that the active product is actually different from the passive products out there,” Cremers says. “If the difference in holdings is not very substantial, it’s unlikely that the fund is going to deliver value for investors, particularly if the fund is not very cheap.”

A recent paper, “Active Share and the Three Pillars of Active Management,” reinforces Cremers’ previous findings on “active share,” a quantitative measure of what percentage of a fund’s portfolio deviates from its benchmark.

A fund with a zero percent active share would precisely replicate its benchmark, while a fund with 100 percent active share would have no overlapping holdings with its benchmark at all.

“A low active share for a large-cap fund is 68 to 70 percent,” Cremers says. “Twenty to 30 percent of large-cap funds have active share that low.”

Low active share products are an indicator of “closet indexing”–portfolio managers who claim to add value but tend not to deviate from their benchmarks.

Cremers studied U.S. retail mutual funds with at least $10 million AUM from 1990 to 2015. During that period, the percentage of assets in funds with active share less than 60 percent peaked during the dot-com collapse at the end of the 1990s and the 2008 global financial crisis, yet has declined steadily since.

“What that really tells you is that the funds that have low active share have lost assets more so than individual funds increasing or decreasing active share,” Cremers says. “Active share at the fund level tends to be very sticky, consistent over time for a particular manager.”

In the same 25-year time period, only funds with the highest quintile of active shares outperformed benchmark indexes, according to Cremers.

As it turns out, when the mutual fund universe is narrowed to high active share funds, active management still beats passive management most of the time, according to Cremers.

“You avoid underperformance by avoiding low active share funds,” he says.

Steve Graziano of Touchstone Investments says that active share gives advisors and managers a metric for a strategy’s quality that’s not dependent on backward-looking measures.

“In the absence of this structure, the only information to make a long-term pick is past performance,” Graziano says. “It’s hard to have conviction to hold onto a fund if all you’ve looked at is past performance.”

Cremers, in partnership with Touchstone Investments, has also announced the launch of ActiveShare.info, a website that allows advisors and investors to research active share across the U.S. mutual fund universe.

Cremers also identifies three pillars of successful active management that complement an understanding of active share: skill, conviction and opportunity.

Active share does not measure skill in stock picking, but a manager’s deviation from its benchmark—thus active share may only be beneficial among managers of high stock picking skill. Yet the lower a fund’s active share, the more difficult it is for a manager to outperform their benchmark, he says.

If a fund has an annual expense ratio of 0.84 percent and a passive product tracking the benchmark is available at 0.15 percent annual expense ratio, its positions need to outperform the benchmark by 0.69 percent each year to cover its additional costs. If that fund has an active share of 49 percent, only half of its portfolio is able to contribute to the outperformance—giving the active share of the fund a hurdle rate of 1.41 percent per year.

Last year, Cremers helped introduce the concept of active fee, which measures the fee charged for the actual level of active management in a fund. As active share decreases, active fee tends to increase, but it should ideally be stable, says Cremers.

Low active share mutual funds tend to underperform their indexes, especially if they have high expenses.

“If you buy cheap funds, you’re going to end up with something close to an index fund,” Cremers says. “It’s not going to give much positive alpha, but it will prevent you from severely underperforming.”

Smart beta also fits into Cremers' universe. Since smart beta strategies have low active share and low fees, over the long term they may provide low or negligible levels of alpha.

High active share mutual funds outperform, but with a lot of volatility. The key differentiator, says Cremers, is a manager’s long-term conviction. Conviction, the willingness to translate identified opportunities into an investment portfolio that is substantially different to outperform, is also not directly measured by active share, but it does differentiate between high active share funds, he says.

Cremers argues that high-conviction managers tend to stick to their stock picks over longer durations, and long-term convictions differentiated successful managers from underperformers among high active share funds.

“Investors judge managers’ performance over much shorter time periods, but it may take at least one to three years before the market recognizes and rewards a manager for their convictions,” Cremers said. “When managers are faced with such short-term performance evaluations, it’s hard for them to perform well. Patient capital is usually not very active—that’s why index funds, generally quite patient, perform well. On average, high conviction managers do fine, especially if they combine with a patient strategy.”

Tactical strategies that frequently move between indexes or stocks tend to underperform, according to Cremers.

High active share typically indicates a lack of constraints on managers, he says. For example, there is less information available for small-cap equity managers. As a result, small-cap funds have a higher active share because they have more opportunity for differentiated stock picking, according to Cremers.

Active share allows investors to determine which funds engage stock picking, and which ones are high-priced “closet indexers,” he says.

“When combined with the three pillars of active management, high active share funds empirically outperform,” says Cremers.