Actively Managed Funds: Why They're Worth Your Investment

Actively managed funds are a type of investment fund where a manager or management team makes decisions about how to allocate the fund's money. These funds aim to beat market returns by allowing professional money managers to hand-pick investments based on their expertise and research. While actively managed funds typically charge higher fees, they offer several advantages, including the potential to outperform the market, the flexibility to adapt to market conditions, and the ability to manage risks more effectively. However, it's important to note that actively managed funds also come with the risk of underperformance and higher taxes and fees due to frequent trading. The choice between actively and passively managed funds ultimately depends on an investor's risk tolerance and investment goals.

Opportunity to beat the market

Actively managed funds offer investors the opportunity to beat the market. This means that they aim to outperform the benchmark index or market sector that they are measured against.

Active funds are managed by professionals who use their expertise, experience, and judgement to hand-pick investments. They have the flexibility to search for better values and make judgement calls that passive funds cannot. For example, active managers can sell a higher-priced stock in a popular index to buy a lower-priced stock that isn't part of the index if they believe it will perform better. They can also use various hedging strategies, such as short selling and derivatives, to mitigate risk.

The ability to deviate from the index is particularly advantageous in the bond market. Passive funds often invest more money in the most indebted companies, as they are the biggest borrowers. However, active managers can choose to invest in less liquid, higher-yielding bonds without extra default risk, earning a higher return.

While actively managed funds offer the opportunity to beat the market, it is important to note that they typically charge higher fees and many fail to beat the market consistently. In fact, studies show that most actively managed funds underperform passive funds over the long term due to the difference in fees. However, this is not always the case, and some active funds have been known to post huge returns.

Access to top money managers

Actively managed funds offer access to top money managers, which can be a significant advantage for investors. These funds are managed by experienced professionals who employ their expertise, judgement, and investment strategies to make active buy, hold, and sell decisions. The goal is to outperform the market and achieve higher returns for investors.

The selection of these top money managers involves a rigorous process. Vanguard, for example, leverages its size and reputation to carefully select partners from across the globe, building deep relationships with their investment teams. The performance of these investment teams is continually evaluated to ensure they meet expectations.

The expertise of these managers lies in their ability to identify undervalued investment opportunities. They conduct extensive research and analysis, utilising quantitative tools and their own judgement to make informed decisions. This flexibility in the selection process allows them to deviate from an index and seek out better values, which can lead to higher returns for investors.

Additionally, active fund managers can also provide benefits in tax management. Their discretion in buying and selling allows them to offset losses with gains, optimising the tax efficiency of the fund.

While actively managed funds offer access to top money managers, it is important to remember that there is no guarantee of outperformance. Studies have shown that most actively managed funds tend to underperform the market index over the long term, and higher fees are typically associated with these funds. However, when actively managed funds do outperform, investors have the opportunity to earn more.

Potential for outperformance

Actively managed funds offer the potential for outperformance, which means they aim to beat the market returns. This is achieved through investments hand-picked by professional money managers, who use their expertise, experience, and judgement to identify stocks that are undervalued. Active fund managers have more flexibility in the selection process and are not restricted to matching the index like passive funds.

The potential for outperformance in actively managed funds comes from the ability of fund managers to deviate from the index. They can sell higher-priced stocks in a popular index and buy lower-priced stocks that are not part of the index, maximising the potential for higher returns. This flexibility allows active managers to search for better values and make judgement calls based on their analysis and experience.

While actively managed funds offer the potential for outperformance, it is important to note that they also come with higher fees. These funds typically charge a flat fee, and many fail to beat the market consistently. In addition, active funds may incur taxes and fees with each transaction, which can impact their overall performance.

Despite the potential drawbacks, some actively managed funds have posted impressive returns. For example, Vanguard's actively managed PRIMECAP Fund generated annualised returns 2.4% higher than its benchmark, the S&P 500 index, since its inception in 1984. This outperformance is attributed to both the acumen of its stock pickers and its relatively low expense ratio.

When considering actively managed funds, it is essential to evaluate the fund's historical performance and the expertise of its managers. While there is a potential for outperformance, actively managed funds also carry the risk of underperformance. Investors should carefully assess their investment goals, risk tolerance, and time horizon before deciding between actively and passively managed funds.

Active funds are more flexible

Passive funds are mandated to buy stocks, meaning they must allocate cash to the stocks they already own, often paying higher and higher prices with no regard for relative value. Active funds, however, can search for better values, investing in higher-yielding bonds without any extra default risk. This flexibility allows active funds to potentially generate higher returns.

The flexibility of active funds also allows investors to benefit from the fund manager's expertise, experience, and judgement. Active fund managers have the freedom to select investments that they believe are undervalued, rather than being restricted to matching the selection and weighting of an index fund. This selection process can be based on the manager's deep research and expertise, allowing them to hand-select stocks or bonds for the fund.

Additionally, the buying and selling flexibility of active funds provides tax management benefits. Active fund managers can offset losers with winners, reducing the tax burden on investors. Furthermore, active fund managers can more nimbly manage risks. For example, in the event of a shock event like the Brexit vote in 2016, an actively managed fund might have reduced its exposure to British banks, while a passive fund would be required to hold a specific number of British banks, potentially leading to significant losses.

Active funds can be opportunistic

Another way active funds can be opportunistic is by taking advantage of market imbalances. Passive funds, which employ rules-based investment strategies, can create imbalances when a large number of investors rush into a popular trade. In contrast, active funds can make judgement calls and deviate from the index, reducing the risk of being impacted by such imbalances. For instance, after the 2016 presidential election, passive funds heavily invested in bank stocks, causing their valuations to rise. Active funds, on the other hand, had the flexibility to invest in other sectors or undervalued banks, potentially benefiting from opportunities that passive funds missed.

Additionally, active funds have an advantage when it comes to investing in bonds and fixed-income securities. Passive funds often struggle in this area due to their rules-based methodologies, which don't always work well in less liquid and standardized markets. Active fund managers, on the other hand, can choose to invest in higher-yielding bonds, earning higher returns without taking on additional default risk. This opportunistic approach to bond investing is a significant advantage for active funds.

Furthermore, active funds can be opportunistic in managing risk. While passive funds are mandated to hold specific investments, active fund managers can reduce exposure to risky assets or sectors. For example, following the Brexit vote in 2016, an actively managed global banking fund could have mitigated risk by lowering its holdings in British banks, while a passive fund would have been required to maintain its positions. Active fund managers' ability to make proactive decisions based on market conditions enhances their risk management capabilities.

Overall, active funds provide opportunities for investors to potentially outperform the market by taking advantage of their flexibility and the expertise of fund managers. While there are no guarantees, active funds offer the potential for higher returns and more effective risk management by being opportunistic in their investment strategies.

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