Definition
Active management refers to a strategy in finance where a portfolio manager makes specific investments with the aim of outperforming an investment benchmark index. It involves the use of analytical research, forecasts, and personalized investment strategies to buy, hold, or sell securities. Portfolio decisions are based on thorough analysis and forecasts rather than following a passive investment strategy.
Key Takeaways
- Active Management involves making investment decisions to outperform certain benchmarks as opposed to passive management which targets at mirroring the investment holdings of a particular index.
- Active managers rely on analytic research, forecasts, and their own judgement and experience in making decisions on what securities to buy, hold, or sell. Thus, the success is largely based on the fund manager’s skill.
- While it may offer higher returns than passive management, it usually comes with higher fees. This is because of the increased trading costs and the need to pay for the investment professionals managing the fund.
Importance
Active Management is an important finance term because it refers to a strategy where a portfolio manager makes specific investment decisions with the objective of outperforming an investment benchmark index.
It plays a crucial role in the financial world as it involves constant monitoring, deep research and frequent adjustments to take advantage of market trends, pricing volatility, economic changes, and investment opportunities that may arise.
The results of active management can sometimes yield higher returns than those of a passively managed portfolio, especially when the market is volatile.
Therefore, it is particularly important to high-risk investors who aim for higher-than-average market returns.
Explanation
Active management is a strategy in investing where portfolio managers continuously monitor and adjust their portfolios with the intention of achieving returns higher than the market average or a specific benchmark index. The core purpose of this strategy is to capitalize on market inefficiencies by actively buying or selling securities based on rigorous research, market forecasts, and the manager’s professional experience and judgment.
This management style is predicated on the belief that the market is not always efficiently priced, providing opportunities for skilled managers to profit from trading or investing in mispriced securities. Active management is used in various investment vehicles like mutual funds, exchange-traded funds (ETFs) etc., seeking to outperform the market.
It may also be employed to mitigate potential losses during periods of market volatility. Techniques such as strategic asset allocation, tactical asset allocation, individual stock selection, and sector rotation are commonly used.
Despite its potential for higher returns, active management typically carries higher costs due to transaction fees, taxation, and research expenses, and hence, must generate greater returns to offset these costs. Additionally, the success of active management heavily depends on the skill and expertise of the designated portfolio manager.
Examples of Active Management
Mutual Funds: A traditional example of active management is the operation of mutual funds. Investment managers within a mutual fund research and select a portfolio of stocks, bonds, or other securities to invest in, based on analyses of risk, market trends, and projected returns. The goal is to outperform a specific benchmark index.
Hedge Funds: Hedge funds are often actively managed as portfolio managers make calculated decisions about when to buy, hold, or sell securities. They might engage in strategies like short selling, leveraging, arbitrage, and derivatives trading to try to generate high returns for investors.
Pension Funds: Some pension funds also use active management strategies. The managers of these funds make decisions about asset allocation and specific investments with the aim of achieving a return that beats the market and ensures the fund can meet its obligations to pensioners.
FAQs on Active Management
What is Active Management?
Active Management, in the financial world, refers to a portfolio management strategy where the manager makes specific investments with the goal of outperforming an investment benchmark index.
What is the main goal of Active Management?
The main goal of Active Management is to generate portfolio returns that exceed the performance of a specific benchmark index, by using various investing strategies and buying/selling decisions of a portfolio’s securities.
What are the benefits of Active Management?
Active management gives the managers the ability to be flexible and adapt to market changes. They can make strategic decisions to seize market opportunities, reduce the impact of market volatility and limit potential losses.
What are the downsides of Active Management?
Active Management usually involves higher transaction costs due to high turnover. It also comes with a risk that the manager may make wrong decision which might result in underperformance relative to the benchmark.
What is the difference between Active Management and Passive Management?
Unlike Active Management, Passive Management involves tracking a market index, often referred to as index investing. In Active Management, investments are more hands-on and try to outperform the market compared to Passive Management where the goal is to mimic the investment holdings and returns of a particular index.
Related Entrepreneurship Terms
- Portfolio Management
- Risk Assessment
- Asset Allocation
- Market Timing
- Investment Selection
Sources for More Information
- Investopedia: This resource provides detailed explanations of finance terminology, including active management.
- Morningstar: Known as an investment research firm providing mutual funds, stocks, and exchange-traded fund details, and includes discussions on active management.
- FXStreet: A reliable source for Forex news and analysis. It also explains concepts related to active management in finance.
- Fidelity: A well-known company providing financial services, offering insights and articles on many topics including active management.
