“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.