Patrick O’Shaughnessy, portfolio manager at O’Shaughnessy Asset Management and curator of the investment blog, The Investor Field Guide, explains that active share – a measure that shows how different a portfolio is from its preferred benchmark – helps measure the “potential” of a fund or strategy’s excess return.

O’Shaughnessy runs a number of simulations that show the outperformance and underperformance potential of a portfolio with varying degrees of active share compared to the S&P 500. While high active share shows massive outperformance potential it also shows that a strategy that looks very different from the benchmark can underperform the benchmark by a huge margin as well. For example, in 1998, which was a year that saw the market jump by 30%, a portfolio with the highest amount of active share would have been down 51% (that’s 81% of underperformance relative to the benchmark).

While active share can be both good and bad, depending on the type of market, one thing is for certain as O’Shaughnessy points out. The degree to which mutual funds have high active share has been shrinking. In “in the early 1980’s, well over half of mutual funds had an active share above 80%, but as of 2009, only 20% or so of funds were this active,” he writes. More and more funds and strategies are “increasingly homogenous, coalescing around indexes and titled variations of those indexes.”