What Is Active Management?
Active management of an investment portfolio refers to a versatile strategy that aims to provide better returns, reduce risks and tax liabilities, manage volatility, and select suitable investments by actively tracking the performance and making decisions. Active managers are investors and mostly professionals who handle and make important decisions related to a portfolio.
Active management investing focuses on outperforming the market or industry benchmarks by identifying gaps and opportunities. Therefore, it requires constant attention and action using various statistical tools, fundamental and quantitative analysis, and forecasting techniques to make quick and well-informed decisions. This differs from passive management, where investors try to replicate an index.
Table of contents
- Active management is an investment approach where investors or finance professionals consider many factors that can potentially affect an investment’s performance. This can help them optimize returns by considering the risk involved, volatility of an investment, and tax benefits.
- It employs various strategies and mathematical techniques for making decisions regarding portfolio management.
- Active managers focus beyond achieving established benchmarks, unlike passive managers, who are often satisfied with achieving the planned objective. Instead, active managers try to surpass the benchmark regarding returns and gains.
Active Management Explained
Active management portfolio involves managing an investor’s portfolio, i.e., considering all the parameters that could affect an investment, industry, or market. Therefore, active managers, like money managers or financial advisors, constantly watch the market and its surroundings. This enables them to make quick buying or selling decisions to give their client better profits.
For example, during the onset of the COVID-19 pandemic, the stock prices of many companies fell drastically. However, online services companies like Netflix, Zoom Video Communications, etc., saw new high prices. Therefore, an active manager could sell off the share they think would underperform and buy the shares of an internet services company instead.
Similarly in the fundamental law of active management, the same manager could foresee the internet companies’ price decline once the governments lifted the lockdowns worldwide and people started moving back to the traditional setup, thus reducing the demand for online services.
One of the important features of active fund management is that its proponents do not support the efficient market hypothesis (EMH). According to the EMH, it is impossible to beat the market in terms of returns on investment. This is because one determines the stock prices by considering all the necessary factors. But active managers believe that the market has some inefficiencies and that it cannot accurately price the stocks. Hence, they aim to profit from the mispricing of stocks.
Unlike those investments that investors trade with intuition and gut feeling, active management funds undergo heavy scrutiny:
- It uses quantitative and qualitative analysis to evaluate the investment and market.
- It forecasts the trends using highly complex statistical tools and theories like a mean reversion, etc.
- Active managers even consider geographical and political impacts on the stock market.
Let us try to understand the concept of active management funds with the help of a suitable example as given below:
Consider this example of ETF active management. According to a recent article by CNBC, actively managed exchange-traded funds (ETFs) are more likely to manage market volatility. In addition, actively managing ETFs can provide tax benefits and liquidity to the investor.
There is an estimated $6 trillion in ETFs, and the market volatility is expected to continue, owing to the rising inflation and interest rates and a fear of recession. Hence, ETF active management can benefit investors in such a turbulent time. However, actively managed ETFs attract a higher fee than passively managed ones.
Let us look at the benefits of active management technology:
- Better returns on investment (ROI)
- Volatility and risk management
- Quick and accurate decision-making
- High responsiveness to the market
- Flexibility in the selection of investments
This active management funds investment strategy has its disadvantages too. Firstly, professionals demand a high fee for active management funds. This is because so much effort, time, and analysis go into actively managing funds.
Further, when the volume of actively managed investments increases, it tends to replicate the performance of the benchmark or index, thus becoming passive. Lastly, many real-life examples show that despite the probable advantages of actively managed funds, active management portfolio shows poorer results than passive management.
Active Management Vs Passive Management
Both concepts above are widely used strategies in the financial market to maximize investment returns and control risk and cost. However, the fundamental law of active management differ from passive management in various aspects; let us study the differences in detail.
The real benefits of active management surface when passive management comes into the picture. Passive management can be explained as the investment approach in which the investment returns resemble a particular index. That is, the investment strategy is not likely to change with capital market expectations but instead places a higher emphasis on the index.
On the other hand, active management investing tries to find opportunities to maximize returns instead of just following the index and making standard market returns. Hence, the risk factor might increase in this case. But there is a higher potential to make better returns in case of active management technology. For this purpose, it uses highly scientific methods and statistical tools compared to passive management, which mostly uses fundamental techniques.
Frequently Asked Questions (FAQs)
Actively managed funds can provide higher returns to investors as it attempts to surpass the index or benchmark. It also identifies inefficiencies and opportunities, which can be used to the investor’s advantage to make better profits.
Yes. Active investment management can work, provided it is employed properly, and many professionals handle every aspect.
Yes. Active portfolio management is a scientific approach to investing. It is versatile and conducive. It focuses beyond the primary factors that can affect investment or market performance. Thus, it can identify the remotest factors that can add to the investor’s profits.
Actively managing funds is considered a step above passively managing them because of their promises and potential. When rightly employed, it can manage the risk and volatility in the market, generate high returns, make fast and better decisions, and predict the likely outcomes.
This article is a guide to what is Active Management. We explain its differences with passive management along with benefits & examples. You can also go through our recommended articles on corporate finance –