Active management

Definition

Active management is an investment strategy where a portfolio manager or team makes specific investments with the goal of outperforming a benchmark index. This approach involves regular buying and selling of assets based on research, market trends, and economic indicators, as opposed to passive management which simply tracks a market index.

5 Must Know Facts For Your Next Test

1. Active management relies on in-depth analysis and decision-making by portfolio managers, who attempt to capitalize on market inefficiencies.
2. This strategy can lead to higher costs due to frequent trading, management fees, and research expenses compared to passive management.
3. Active managers aim for alpha, which is the excess return on an investment relative to the return of a benchmark index.
4. The success of active management often hinges on the skill and experience of the manager, as well as their ability to forecast market movements.
5. Research indicates that only a small percentage of active managers consistently outperform their benchmarks over long periods, raising questions about the effectiveness of active management.

Review Questions

• How does active management differ from passive management in terms of strategy and objectives?
  • Active management differs from passive management primarily in its approach and goals. Active managers seek to outperform a benchmark index through strategic buying and selling based on extensive research and market analysis. In contrast, passive management aims to replicate the performance of a specific index without attempting to beat it, resulting in less trading activity and often lower costs. The key distinction lies in the proactive decision-making involved in active management compared to the more hands-off nature of passive strategies.
• Discuss the potential advantages and disadvantages of employing an active management strategy for investors.
  • The potential advantages of active management include the opportunity for higher returns through strategic asset selection and the ability to respond quickly to market changes. However, disadvantages include higher fees associated with frequent trading and potential underperformance compared to benchmarks. Moreover, many active managers struggle to consistently deliver alpha over time, leading some investors to question whether the additional costs are justified when compared to lower-cost passive alternatives.
• Evaluate the implications of active management's reliance on portfolio manager expertise in relation to overall market efficiency.
  • Active management's reliance on portfolio manager expertise suggests that skilled individuals can identify inefficiencies in the market and exploit them for profit. This raises interesting implications for overall market efficiency. If too many active managers are successful at outperforming their benchmarks, it could indicate that markets are not fully efficient, as inefficiencies would still exist. Conversely, if most active managers fail to consistently beat their benchmarks, it supports the efficient market hypothesis, which posits that all available information is already reflected in asset prices.

Related terms

benchmark index: A standard against which the performance of an investment portfolio can be measured, typically represented by a specific stock market index.

portfolio management: The art and science of making decisions about investment mix and policy to match the investment objectives of the investor.

passive management: An investment strategy that aims to replicate the performance of a specific index or benchmark, typically involving less frequent trading and lower costs compared to active management.