Actively Managed Investments: What Are They?

Actively managed investments are those in which a portfolio manager or team of managers attempts to beat the market by generating returns and managing risk. Active investors seek to profit from market inefficiencies by buying and selling investments where the market price is lower or higher than the underlying value. Active investors use various techniques, including fundamental and quantitative analysis, to identify mispriced investments. Actively managed funds generally have higher fees and are less tax-efficient than passively managed funds. However, they offer more flexibility in investment selection and allow for better tax management and risk management.

Active vs passive investing

The choice between active and passive investing depends on an investor's financial goals, risk appetite, and level of expertise. Active investing involves making investment decisions based on an investor's or fund manager's convictions, while passive investing aims to replicate the success of the market. Active investing is often used by hands-on, experienced investors who trade frequently, while passive investing is more common among retail investors and beginners.

Active Investing

Active investing attempts to beat the market by selecting different investments than the index or trying to time the market. Active fund managers can provide increased flexibility and trading strategies, such as shorting stock or hedging to protect against potential losses. They can also provide risk management by getting out of specific holdings or market sectors when risks become too large. Additionally, active fund managers can offer tax management strategies, such as tax-loss harvesting to lower an investor's tax liability. However, active investing generally requires higher fees due to the need for more frequent trading and more specialized expertise.

Passive Investing

Passive investing, on the other hand, involves buying and holding funds or investments that aim to match the returns of an index, rather than trying to outperform it. Passive investing is a low-cost, long-term strategy that provides easy diversification by investing in a broad range of stocks, bonds, and other assets. It is considered lower risk than active investing, as it is based on the belief that markets are efficient and that it is challenging to consistently beat the market over the long term. Passive investing is also more tax-efficient due to fewer taxable events, such as capital gains. However, passive investing can be more limiting as fund managers cannot adapt to changing market conditions.

The decision between active and passive investing depends on various factors, including an investor's goals, risk tolerance, and expertise. Passive investing is often recommended for beginners as it provides diversified exposure with lower risk and costs. On the other hand, active investing may be more suitable for experienced investors who are comfortable with taking on more risk to potentially achieve higher returns. Ultimately, some investors may also choose to combine both strategies, depending on their beliefs around market efficiency and their risk/reward perspective.

Advantages of active management

Active management is an approach to investing where the investor or a dedicated fund manager selects the investments that make up a portfolio. Active investors aim to generate additional returns by buying and selling investments advantageously. Active management is often compared to passive management, which follows a simple rule of trying to track an index or benchmark. Here are some advantages of active management:

• Expertise and Experience: Active fund managers bring their expertise, experience, and judgment to the table. They employ various techniques, such as fundamental and quantitative analysis, to identify mispriced investments and select undervalued stocks that have the potential to outperform the market.
• Flexibility: Active management offers more flexibility in the investment selection process compared to passive management, which must closely match the selection and weighting of investments in an index. Active investors can tailor their investments to match their risk tolerance and adjust their portfolios as their personal circumstances change.
• Tax Management Benefits: The flexibility of active management allows fund managers to offset losers with winners, providing benefits in tax management. Active investors can also time the sale of investments with capital gains for tax-planning purposes.
• Risk Management: Active fund managers can more nimbly manage risks. For example, in the case of heightened risk, an actively managed fund might reduce its exposure to certain sectors or holdings. Additionally, active managers can use hedging strategies, such as short selling and derivatives, to further mitigate risk.
• Potential for Higher Returns: Active management provides investors with the potential to earn higher returns by selecting investments that can outperform the market. Even seemingly small amounts of excess return can lead to significantly better outcomes over time.

Disadvantages of active management

Actively managed funds generally have higher fees and are less tax-efficient than passively managed funds. The investor pays for the sustained efforts of investment advisers who specialise in active investment and for the potential for higher returns than the market as a whole.

There is no consensus on which strategy yields better results: active or passive management. An investor considering active management should carefully examine the actual returns after fees of the manager.

Actively managed funds often set minimum investment thresholds for prospective investors. For example, a hedge fund might require new investors to make a starting investment of $250,000.

The cost of active investing can be high due to the potential for numerous transactions. If an investor is continually buying and selling stocks, commissions may significantly impact the overall investment return. Active management fees can range from 0.10% to over 2% of assets under management (AUM). Active money managers may also charge a performance fee of between 10% and 20% of the profit they generate.

The success or failure of active management depends largely on which of the contradictory statistics is quoted. While some studies show that active managers have outperformed benchmarks over specific time periods, particularly in specialised sectors or regions, there is no overall agreement that active management yields better results.

Active management performance

One of the key advantages of active management is the potential for higher returns. Active fund managers use their expertise and research capabilities to hand-select stocks or bonds that they believe will outperform the market. They aim to take advantage of market inefficiencies by buying undervalued investments and selling overvalued ones. This flexibility in investment selection allows active managers to tailor their portfolios to match their risk tolerance and generate higher returns.

However, active management also comes with higher fees and increased tax inefficiency. Actively managed funds generally have larger expense ratios because they require more resources for research and analysis. Additionally, active fund managers may trade more frequently, resulting in higher taxable capital gains. These factors can offset some of the potential gains achieved through active management.

The performance of active management has been evaluated by various reports, such as the SPIVA report and the Morningstar Active-Passive Barometer. These reports often conclude that actively managed funds underperform their passive counterparts. For example, the SPIVA U.S. Year-End 2021 report found that nearly 80% of domestic equity funds lagged the S&P Composite 1500 in 2021.

On the other hand, some companies like Fidelity, claim to have a history of demonstrating the success of active management. They attribute this success to their ability to adapt quickly to changing markets and select investments with the potential to outperform. Additionally, active management offers advantages such as flexibility, hedging capabilities, and risk management, which can be beneficial in certain market conditions.

In conclusion, active management performance is a complex and controversial topic. While active management provides the opportunity for higher returns and offers advantages such as flexibility and risk management, it also comes with higher fees and tax inefficiencies. The success of active management depends on various factors, and there is no consensus on whether it consistently outperforms passive management.

Active management and the markets

Active management is an approach to investing where the investor or a dedicated fund manager selects the investments that make up a portfolio. Active investors seek to generate additional returns by buying and selling investments advantageously. They look for investments where the market price is lower than the underlying value and will buy investments when the market price is too low and sell when the price is too high. This is in contrast to passive management, where investments are chosen to mirror a particular market index.

Active investors use various techniques to identify mispriced investments, including fundamental analysis and quantitative analysis. Fundamental analysis evaluates individual investments to assess their risk and potential return, while quantitative analysis uses data to establish a systematic process for buying and selling. Active investors may also use their own judgement and experience to make decisions.

Active management can be applied to security selection, asset allocation, and sustainable investing. It allows investors to tailor the risk of their investments to match their risk tolerance and adjust exposures to reflect existing exposures. For example, employees of high-tech companies might wish to limit their exposure to high-tech stocks in their investment portfolios. Active investors can also emphasise income generation and time the sale of investments for tax-planning purposes.

One of the key advantages of active management is the potential for higher returns. Active investors can use their expertise to select investments that outperform the market. Active management also offers more flexibility than passive management, allowing investors to align their portfolios with their goals and adjust their investments as their personal circumstances change.

However, there are also disadvantages to active management. Actively managed funds generally have higher fees and may be less tax-efficient than passively managed funds. Active management requires sustained efforts from investment advisors, resulting in higher costs for investors. Additionally, active managers may trade more frequently, triggering larger annual capital gains taxes.

Despite these disadvantages, active management plays a crucial role in maintaining market efficiency. Active managers establish market prices for securities through their buying and selling decisions. An increase in active management leads to greater market efficiency, encouraging broader investor participation, easier risk diversification, and capital formation. Actively managed portfolios are also essential buyers of initial public offerings of securities, contributing to capital formation.

Frequently asked questions