What Is Active Management in Investing? This article will answer that question. Let’s start with a definition. An active manager manages assets that are not held by other investors. The objective is to maximize returns for investors while limiting risk. An active manager manages only assets with a certain risk profile, and its fee is based on that risk profile. A manager’s performance can be measured by its fee, which is usually one percent of the total value of the portfolio.
Most active managers are obligated to their clients, and they generally invest in a handful of undervalued companies. These managers are called stock-pickers because they invest a significant amount of their portfolio into each portfolio company. They also engage with these companies positively and actively try to influence change for the better. Hence, active managers are generally not the best choice for investors. If a manager’s performance falls below expectations, there is a chance that it will be fired.
What Is Active Management in Investing? Active managers use investment analysis, forecasts, quantitative tools, judgment, and experience to make investment decisions. While they are less likely to take a losing position, they aim to generate superior returns than passive managers. Active managers often reject stronger forms of the efficient market hypothesis, which says that beating the market is impossible over the long-term because all publicly available information has been incorporated into stock prices.
Passive management, on the other hand, is based on simple rules and replicating an index. Advocates of passive management believe that buying indexes and ignoring human bias is the best way to achieve high returns. Investing in active management involves a portfolio manager and a team of analysts. The managers use quantitative and qualitative analysis to make investing decisions. The objective of active management is to achieve higher returns while minimizing risk and tax consequences.
One advantage of active managers is that they think long-term, minimizing trading costs. Patience is often the key to maximizing returns. With the current market inefficiency, average holding periods are decreasing as market participants react too quickly. Consequently, patience is an important virtue for active managers. In the US, research has shown that funds with high levels of patience outperform indexes by up to two percent annually.
Passive investors do not have an off ramp in case the market has a downturn. The market is built for the long-term, and historically it recovers from every correction. While this may seem optimistic, it does not necessarily mean that the market will recover quickly. An active investor can benefit from regular asset allocation revision as the timeline nears. The key difference between active and passive investing is the timeframe. Passive investors can invest in stocks and bonds, while active investors can take advantage of volatile markets by reducing risk.
In short, active managers aim to produce better returns than passively managed index funds. A large-cap stock fund manager, for example, tries to beat the Standard & Poor’s 500 index. However, most active managers have had difficulty outperforming the market. And they also have higher fees. The benefits of active management are worth it, though they don’t guarantee index-beating performance. This is a topic of hot debate and a subject for a future article.