What is active management
Active management is the use of a human element, such as a single manager, co-managers or a team of managers, to actively manage the portfolio of a fund. Active managers rely on analytical research, forecasts and their own judgment and experience in making investment decisions on the securities to buy, hold and sell. The opposite of active management is passive management, better known as “indexing”.
Break active management
Investors who believe in active management do not follow the assumption of an efficient market. They believe it is possible to profit from the stock market through a number of strategies aimed at identifying poorly valued securities. Investment companies and fund sponsors believe that it is possible to outperform the market and employ professional investment managers to manage one or more of the company’s mutual funds. David Einhorn, founder and president of Greenlight Capital, is an example of a well-known active fund manager.
Objective of active management
Active management seeks to produce better returns than those of passively managed index funds. For example, a large-cap equity fund manager is trying to beat the performance of the Standard & Poor’s 500 index. Unfortunately, for the vast majority of active managers, this has been difficult to achieve. This phenomenon is simply a reflection of the difficulty, whatever the talent of the manager, in beating the market. Actively managed funds generally have higher fees than passively managed funds.
Benefits of Active Management
The expertise, experience, skills and judgment of a fund manager are used when investing in an actively managed fund. For example, a fund manager may have extensive experience in the automotive industry; therefore, the fund may be able to beat benchmark returns by investing in a selected group of car-related stocks which, according to the manager, are dumped. Active fund managers have flexibility. There is generally freedom in the stock selection process as performance is not tracked towards an index. Actively managed funds provide tax management benefits. The possibility of buying and selling when deemed necessary makes it possible to compensate for the loss of investments with winning investments.
Active management and risks
By not having to follow specific benchmarks, active fund managers can manage risk more effectively. For example, a global exchange traded bank fund (ETF) may be required to hold a specific number of UK banks; the fund is expected to have declined significantly in value after the Brexit shock in 2020. Alternatively, an actively managed global bank fund has the ability to reduce or terminate its exposure to UK banks due to increased risk levels. Active managers can also mitigate risk by using various hedging strategies such as short selling and using derivatives to protect the portfolios.
Active management and performance
Controversy surrounds the performance of active managers. Whether investors will benefit from better results with an actively managed fund as opposed to a mechanically traded ETF depends on who manages the fund and the time period. Over the 10-year period ended in 2020, active managers who invest in large-cap value stocks were the most likely to beat the index, outperforming by 1.13% on average per year. A study has shown that 84% of active managers in this category have outperformed their benchmark index gross of commissions. In the short term – three years – active managers underperformed the index by 0.36% on average, and over five years, they followed it by 0.22%.
Another study showed that for the 30 years ended in 2020, actively managed funds yielded an average of 3.7% per year, compared with 10% for the returns of passively managed funds. (For a related reading, see “Passive or active portfolio management: what’s the difference?”)