Teams of two to four managers showed less portfolio overlap in their portfolios than single managers, which suggests that collaborative decisions lead to less herding behavior.
formance across various time horizons.
The Promise: Strong Predictive Power
The initial findings seemed encouraging. The authors reported that their portfolio overlap measure“ strongly predicts funds’ future extra performance” and correlates with three key managerial skills:
1. Value recognition: They asked whether the fund managers were buying undervalued stocks and selling overvalued ones.
2. Security selection: They asked whether the managers were choosing stocks that outperformed characteristic-based benchmarks.
3. Style timing: They asked whether the managers were effectively timing different investment approaches.
Low-overlap funds generated statistically significant gross alphas of approximately 1.5 % annually across various factor models, suggesting that there was real skill differentiation.
The Critical Distinction: Is It Risk- Adjusted?
While the research did show that portfolio overlap patterns can predict which funds will outperform their peers, it didn’ t matter as much when it came to net returns( the only returns that matters to investors). Even the funds with the lowest overlap failed to generate positive alphas across any of the factor models when it came to net return.
This creates an important paradox: When it comes to relative performance, low-overlap funds outperform high-overlap peers( which produce large and statistically significant negative alphas). But when it comes to absolute performance, both groups typically underperform riskadjusted benchmarks( so both result in negative alpha). So even if the model offers the powers of prediction, it only works for comparing names within the mutual fund universe, not for beating passive benchmarks. These findings were robust even when applied to various time horizons.
What This Really Reveals About Manager Skill
The negative net alphas across all factor models tell us three important things:
1. Active Managers Face a Persistent Challenge
Even funds with highly differentiated portfolios struggle to overcome fees and transaction costs— confirming that consistently beating risk-adjusted benchmarks remains extraordinarily difficult. 2. Skill Doesn’ t Equal Profit A manager who avoids portfolio overlap might demonstrate analytical skills about security selection and recognize value, but those abilities aren’ t usually enough for them to generate positive alpha after they’ ve accounted for realworld costs. 3. Relative Rankings Still Matter Still, even if these active managers deliver negative absolute alphas, investors dedicated to active strategies will benefit from their ability to identify superior active managers delivering more value than those active peers.
There are two bonus insights worth mentioning. One is that there’ s an advantage to team management. Teams of two to four managers showed less portfolio overlap in their portfolios than single managers, which suggests that collaborative decisions lead to less herding behavior. Yet, notably, this advantage disappears when the team’ s size grows beyond four members. The second insight is that industry selection has its limitations and by itself was insufficient to generate excess returns.
Key Takeaways For Investors From this we can take away a few conclusions. 1. Overlap analysis is a relative ranking tool, not an alpha generator.
The research provides a method for choosing among active funds, not for beating passive( systematic) strategies. If you’ re committed to active management, overlap analysis can help you pick better managers within that universe. But the negative alphas suggest most investors are better served by low-cost, systematically managed funds.
2. We should reframe our performance expectations.
If we understand that even“ skilled” active managers typically generate negative risk-adjusted returns, that will help us set more realistic expectations. Portfolio overlap helps identify managers who lose less but doesn’ t help us find managers outperforming appropriate risk-adjusted benchmarks.
3. We should consider the full cost of active management.
The negative alphas the authors discovered in the study should reinforce the idea that fees are an important consideration in active fund selection.
4. We shouldn’ t abandon passive( systematic) strategies.
The research itself strengthens this argument. Yes, it identifies the relative skill differences among active managers, but then shows how difficult it is for them to consistently generate positive alpha.
Investors should lastly take this away: Rather than revolutionizing active fund selection, this research helps investors make better decisions only when working within an active management framework, while otherwise showing why systematic strategies remain the better option for most investors.
LARRY SWEDROE is the author or co-author of 18 books on investing, including his latest, Enrich Your Future. He is also a consultant to RIAs as an educator on investment strategies.
NOVEMBER 2025 | FINANCIAL ADVISOR MAGAZINE | 39