(April 30, 2014) — Managers who move the furthest away from indexes and hold concentrated portfolios outperform benchmarks and peer groups, according to Cambridge Associates.

The consultant has issued a paper to try, once and for all, to settle the age-old tussle of active vs. passive management.

“For some institutions, the challenges may be valid roadblocks, and thus make a good argument for pursing a passive approach to building an equity allocation,” said Kevin Ely, senior investment director at Cambridge Associates. “For others, overcoming the implementation obstacles can form the basis for a valuable relative return premium to be earned by investing with the right differentiated managers for the right time horizons.”

The study observed US large-cap, small-cap, and non-US managers from October 2007 to June 2013 and possible correlations between active share, portfolio concentration, and overall performance.

The analysis showed that among US large-cap managers, the average highest-quartile active share manager outperformed those in the lowest-quartile by 73 basis points (bps), gross of fees. The difference was the same for US small-cap managers.

“Our analysis indicates that, on average, the incremental performance of higher active share and more concentrated portfolios more than justifies the incremental fees,” Ely said. “The investor must be able to accept this—and, of course, select the right managers.”

There were similar findings for portfolio concentration, or the number of positions a manager holds. Cambridge Associates found that the average concentrated manager—those with 30 or fewer holdings—outpaced the average unconcentrated manager by over 125 bps. For small cap managers, the outperformance was 100 bps, and 170 bps for non-US managers.

And as high active share and more concentrated managers are not always correlated with a high tracking error, investors could achieve even greater returns with managers that implement risk factor exposures, the study argued.

However, investors must be wary of “behavioral and logistical challenges,” Ely wrote.

“Institutions should assess their ability to manage these challenges and match their expectations with their circumstances when assessing their probability of long-term success in active equity manager selection,” he said.

The limited supply of “optimal” managers, higher fees, and increased volatility that is generally associated with high active share and portfolio construction could pose challenges to choosing successful managers, the report said.

Most of all, investors should be careful not to “exit at the wrong time,” often costing them significant costs in hiring and firing managers.

“In investing, the willingness, capability, discipline, and resources to overcome implementation challenges, such as limited supply of appropriate managers and investor behavior patterns, can pave the path to more attractive results,” Ely said.