What is active management?
The term active management implies that a professional fund manager or a team of professionals monitors the performance of a client’s investment portfolio and regularly makes buy, hold and sell decisions regarding the assets it contains. . The objective of the active manager is to outperform the overall market.
Active managers can rely on investment analysis, research and forecasting as well as their own judgment and experience to make decisions about which assets to buy and sell.
The opposite of active management is passive management, better known as indexation. Those who adhere to passive management argue that the best results are obtained by buying assets that reflect one or more particular market indices and holding them for the long term, ignoring daily market fluctuations.
Understanding active management
Investors who believe in active management do not follow the efficient market assumption that you cannot beat the market over the long term. That is, stockpickers who spend their days buying and selling stocks to exploit their frequent fluctuations, over time, will do no better than investors who buy the components of the major indices used to track the market. performance of larger markets over time.
Key points to remember
- Active management requires constant monitoring and frequent buy and sell decisions to exploit price fluctuations.
- Passive management is a buy and hold strategy that aims to match the returns of the broader market.
- Active management seeks returns that exceed the performance of all the markets.
Active managers, on the other hand, measure their own success by measuring how well their portfolios exceed (or fall below) the performance of a comparable unmanaged index, industry or market sector.
For example, the Fidelity Blue Chip Growth Fund uses the Russell 1000 Growth Index as a benchmark. In the five years ended June 30, 2020, the Fidelity fund returned 17.35% while the Russell 1000 Growth Index increased 15.89%. Thus, the Fidelity fund outperformed its benchmark index by 1.46% over this five-year period.
Active management strategies
Active managers believe that it is possible to profit from the stock market through one of the many strategies aimed at identifying stocks that are trading below what their value deserves.
Investment firms and fund promoters believe that it is possible to outdo the market and employ professional investment managers to manage the firm’s mutual funds.
Disadvantages of active management
Actively managed funds have higher fees than passively managed funds. The investor pays for the sustained efforts of investment advisers specializing in active investing and for the potential for returns above those of the markets as a whole.
There is no consensus on which strategy gives the best results: active or passive management.
Passive management requires a one-time effort to select the right assets for an individual investor, followed by occasional rebalancing of a portfolio and due diligence to track it over time.
An investor who is considering active management should carefully consider actual returns after the manager’s fees.
Benefits of active management
The expertise, experience and judgment of a fund manager are employed by investors in an actively managed fund. An active manager who manages an auto industry fund may have extensive experience in the field and may invest in a select group of auto-related stocks which the manager believes are undervalued.
Active fund managers have more flexibility. The selection process is freer than in an index fund, which must correspond as closely as possible to the selection and weighting of investments in the index.
Actively managed funds provide advantages in tax management. Flexibility in buying and selling allows managers to match the losers with the winners.
Active fund managers can manage risk with more agility. A global bank exchange traded fund (ETF) may be required to hold a specific number of UK banks. This fund is likely to have fallen significantly following the shock Brexit vote in 2016. An actively managed global banking fund, meanwhile, could have reduced its exposure to UK banks due to the heightened risk levels.
Active managers can also mitigate risk by using various hedging strategies such as short selling and the use of derivatives.
Active management performance
There are many controversies surrounding the performance of active managers. Their success or failure largely depends on the contradictory statistic cited.
Over the 10 years ended 2017, active managers who invested in large-cap value stocks were the most likely to beat the index, outperforming an average of 1.13% per year. A study showed that 84% of active managers in this category outperformed their benchmark index before fees were deducted.
But in the short term – three years – active managers have underperformed the index by 0.36% on average, and over five years, they have followed it by 0.22%.
Another study showed that for the 30 years ending in 2016, actively managed funds generated an average annual return of 3.7%, compared to 10% for passively managed funds.