This document provides information on active and passive portfolio management strategies. Active management aims to outperform benchmarks by frequently trading securities selected through research. Passive management replicates indexes at low cost by holding securities long-term. While active strategies may achieve higher returns, they also take on greater risk and fees than passive strategies, which provide transparency and tax efficiency. The key difference is that active managers believe the market can be beaten while passive managers do not.
This document provides information on active and passive portfolio management strategies. Active management aims to outperform benchmarks by frequently trading securities selected through research. Passive management replicates indexes at low cost by holding securities long-term. While active strategies may achieve higher returns, they also take on greater risk and fees than passive strategies, which provide transparency and tax efficiency. The key difference is that active managers believe the market can be beaten while passive managers do not.
This document provides information on active and passive portfolio management strategies. Active management aims to outperform benchmarks by frequently trading securities selected through research. Passive management replicates indexes at low cost by holding securities long-term. While active strategies may achieve higher returns, they also take on greater risk and fees than passive strategies, which provide transparency and tax efficiency. The key difference is that active managers believe the market can be beaten while passive managers do not.
This document provides information on active and passive portfolio management strategies. Active management aims to outperform benchmarks by frequently trading securities selected through research. Passive management replicates indexes at low cost by holding securities long-term. While active strategies may achieve higher returns, they also take on greater risk and fees than passive strategies, which provide transparency and tax efficiency. The key difference is that active managers believe the market can be beaten while passive managers do not.
Paper: Security Analysis & Portfolio Management (MCM-405A) Unit: IV Topic: Active and Passive Portfolio Management
-Prepared by Mr. Hari Mall Thakuri, Assistant Prof.,
Dept. of Commerce, USTM
ACTIVE VS. PASSIVE PORTFOLIO MANAGEMENT
Investors have two main investment strategies that can be used to generate a return on their investment accounts: active portfolio management and passive portfolio management. Active portfolio management focuses on outperforming the market in comparison to a specific benchmark such as the Standard & Poor's 500 Index. Passive portfolio management mimics the investment holdings of a particular index in order to achieve similar results. As the names imply, active portfolio management usually involves more frequent trades than passive management. An investor may use a portfolio manager to carry out either strategy, or may adopt either approach as an independent investor
ACTIVE PORTFOLIO MANAGEMENT
The foremost aim of active portfolio management is to overtake the returns of its underlying benchmark index. The premise behind active management is that a skilled portfolio manager, backed by a specialist investment team, can select such securities for a portfolio which would surpass returns posted by its benchmark index or some other relevant measure of portfolio performance. Investors pay a fee to the portfolio manager for his expertise and experience that goes into securities selection with expectations that his in-depth research would yield favorable results which will compensate for the fee which is typically higher than a passive strategy The investor who follows an active portfolio management strategy, buys and sells stocks in an attempt to outperform a specific index, such as the Standard & Poor's 500 Index or the Russell 1000 Index. An actively managed investment fund has an individual portfolio manager, co-managers, or a team of managers all making investment decisions for the fund. The success of the fund depends on in-depth research, market forecasting, and the expertise of the management team. Portfolio managers engaged in active investing follow market trends, shifts in the economy, changes to the political landscape, and any other factors that may affect specific companies. This data is used to time the purchase or sale of assets. Proponents of active management claim that these processes will result in higher returns than can be achieved by simply mimicking the stocks listed on an index.1 Since the objective of a portfolio manager in an actively managed fund is to beat the market, this strategy requires taking on greater market risk than is required for passive portfolio management.
PASSIVE PORTFOLIO MANAGEMENT
The investment philosophy behind passive portfolio management is based on Efficient Market Hypothesis. This theory postulates that financial markets are efficient pricing-wise. All investors have all information available to them at all times with no inside information which could benefit a certain segment of the market. If this is the case, then there is little room, if any, for an investor to beat the market, thus making active management less effective. Due to this, passive portfolio management focuses on decreasing costs which it does by following a buy- and-hold strategy which entails low portfolio turnover. Passive portfolio management is also referred to as index fund management. The portfolio is designed to parallel the returns of a particular market index or benchmark as closely as possible. For example, each stock listed on an index is weighted. That is, it represents a percentage of the index that is commensurate with its size and influence in the real world. The creator of an index portfolio will use the same weights. The purpose of passive portfolio management is to generate a return that is the same as the chosen index. A passive strategy does not have a management team making investment decisions and can be structured as an exchange-traded fund (ETF), a mutual fund, or a unit investment trust. Index funds are branded as passively managed rather than unmanaged because each has a portfolio manager who is in charge of replicating the index.2 Because this investment strategy is not proactive, the management fees assessed on passive portfolios or funds are often far lower than active management strategies. Index mutual funds are easy to understand and offer a relatively safe approach to investing in broad segments of the market.
KEY TAKEAWAYS Active management requires frequent buying and selling in an effort to outperform a specific benchmark or index. Passive management replicates a specific benchmark or index in order to match its performance. Active management portfolios strive for superior returns but take greater risks and entail larger fees. Important: Passive portfolio management is also known as index fund management.
ACTIVE VS PASSIVE PORTFOLIO MANAGEMENT
The aforementioned definitions of the two approaches to portfolio management outline the basic difference in investment philosophies: while active management believes that market returns can be exceeded, passive management believes it is futile to try to do so. To elucidate their differences further, we can look at their strengths and weaknesses as for the most part, the strength of one strategy is a weakness for the other and vice-versa.
BEAT MARKET RETURNS
One strength of active portfolio management is that it provides an opportunity to beat market returns and the fact that some actively managed mutual funds do better their passively managed peers which have the same benchmark, shows that there are inefficiencies in the market which skilled portfolio managers can use to their advantage. On the other hand, the best passive portfolio management can do is match market returns.
UNDERTAKE VARIOUS STRATEGIES
Active management also allows portfolio managers to undertake various strategies which can mitigate risks associated with particular market segments during difficult times. For instance, if the banking sector is struggling due to poor performance or facing headwinds due to some new regulation, active managers can reduce or eliminate exposure to the sector to reduce the overall risk to the portfolio. Passive management, on the other hand, does now allow this benefit. In order to save costs, a passive portfolio has to mostly stay the course it has chosen and in the aforementioned case, will have to take losses.
LOW COST Among the benefits provided by passive management, low cost is the foremost. If one buys into an exchange-traded fund (ETF) which replicates an index like the S&P 500 or Russell 3000 or others, one can get by paying a very low fee as compared to nearly all actively managed products. Further, there are passive ETFs for almost all market segments market-cap wise, industry-wise, and geography-wise which investors can use to diversify investments across the spectrum while still paying the low fee.
TRANSPARENCY Transparency can also be attributed to passive portfolios, specifically when it comes to ETFs. These funds disclose their holdings each day after the close of trading thus keeping investor in the know at all times. On the other hand, since active management strategies are designed to beat the market, portfolio managers remain guarded about their positions. Even among mutual funds, portfolio holdings are usually disclosed only once in a quarter.
TAX EFFICIENT Also, given that portfolio turnover in passive portfolio management is low, this strategy is more tax efficient that active management where portfolios are rebalanced quite frequently in an attempt to deliver higher than market returns, which, in turn, results into higher costs.
Index Funds: A Beginner's Guide to Build Wealth Through Diversified ETFs and Low-Cost Passive Investments for Long-Term Financial Security with Minimum Time and Effort
Index Funds: A Beginner's Guide to Build Wealth Through Diversified ETFs and Low-Cost Passive Investments for Long-Term Financial Security with Minimum Time and Effort
