What Is Active Management?
Let me explain active management to you directly: it's when an investor, a professional money manager, or a team tracks an investment portfolio's performance and decides on buying, holding, or selling assets. The aim is to beat a specific benchmark while handling other objectives like risk control, tax minimization, or following environmental, social, and governance (ESG) standards. Active managers stand out in how they pursue these goals.
For instance, they might use investment analysis, research, forecasts—including quantitative tools—and their own experience and judgment to choose assets. Their methods can be fully algorithmic, completely discretionary, or a mix of both.
Comparing to Passive Management
In contrast, passive management—often called indexing—follows basic rules to mirror an index or benchmark. Advocates argue that buying assets to replicate a market index yields the best results by eliminating human biases, leading to superior performance. Yet, studies on active versus passive keep the debate going without a clear winner.
Key Takeaways
- Active management involves making buy and sell decisions about portfolio holdings.
- Passive management aims to match the returns of an index.
- Active management seeks to exceed market performance, manage risk, boost income, or meet goals like sustainable investing.
Understanding Active Management
If you believe in active management, you're not buying into the strong efficient market hypothesis (EMH), which claims it's impossible to consistently beat the market because all information is already in stock prices. EMH supporters say stock pickers will underperform long-term compared to those buying index components. But active managers argue that if your goals go beyond just tracking an index, active approaches fit better.
They gauge success by how much their portfolios beat or lag a comparable index, sector, or market. Take the Fidelity Blue Chip Growth Fund: it uses the Russell 1000 Growth Index as its benchmark. From the five years ending June 30, 2020, it returned 17.35% versus the index's 15.89%, outperforming by 1.46%. They also evaluate risk and other goals, crucial for retirees with shorter horizons.
Strategies for Active Management
Active managers think they can profit by spotting undervalued stocks using fundamental, quantitative, and technical analysis. They might apply asset allocation tied to fund goals. Many firms hire pros to manage mutual funds, adapting to market shifts and innovations.
Disadvantages of Active Management
Actively managed funds typically charge higher fees and are less tax-efficient than passive ones. You're paying for expert advice and the chance at above-market returns. There's no agreement on whether active or passive performs better overall. If you're considering it, scrutinize the manager's after-fee returns.
Advantages of Active Management
You get a manager's expertise, experience, and judgment in an active fund. For example, an auto industry fund manager with deep knowledge might pick undervalued auto stocks. Active managers have more flexibility than index funds, which must closely match the index. They can also optimize taxes by offsetting losses with gains.
Managing Risk
Active managers handle risks more agilely. A passive global banking ETF might be stuck holding British banks during the 2016 Brexit shock, leading to drops. An active fund could cut exposure to those risks. They use hedging like short selling or derivatives to mitigate threats.
Active Management Performance
Performance debates rage on, with stats conflicting. Over the 10 years ending 2021, active managers in domestic small growth stocks often beat indexes—88% outperformed before fees, per one study. Success hinges on the category and period you examine.
Other articles for you
An industry groups similar companies based on their primary business activities, distinct from broader sectors, aiding investors in analysis.
Micro-investing platforms enable users to invest small amounts of money effortlessly, often by rounding up purchases, to build savings over time.
A trading platform is software for trading securities online through brokers, offering features like charts and quotes with varying fees and types.
A lien sale is a public auction of a claim on an asset to recover unpaid debts, commonly involving property, vehicles, or other items.
Thomas Malthus was a British economist famous for his theory that population growth outpaces food production, leading to inevitable crises like famine and war.
A depository is a facility or institution that safely holds and manages deposits of money or securities, providing security, liquidity, and trading assistance.
Kurtosis measures the tailedness of a data distribution to assess investment risk from extreme price fluctuations.
Group health insurance provides affordable coverage to groups like employees, spreading risk to lower costs.
An inside day is a two-day chart pattern where the second day's price range is fully within the first day's, often signaling a continuation of the prior trend with reduced volatility.
Half stock is a security with a par value half of the standard, functioning like regular stock but often as preferred stock with adjusted dividends and claims.