Active management is a style of managing investor funds. It tries to add value to the investment process by trying to beat the market (a benchmark index) with the performance of the funds at hand. The aim is to generate alpha.
Under active management, the fund manager chooses the securities to invest in with the funds, based on their analysis and conviction.
Active management is often discussed in the context of mutual funds (MFs), as fund houses appoint managers to steer the pooled investor money.
Active management requires the fund manager’s active involvement and judgment. The effort to pick securities on behalf of the investors entails a higher fee compared to passive management and higher trading costs. Active Management should outperform the average passively managed funds. It involves the use of fundamental and technical analysis.
Two kinds of approaches are followed:-
- Top-down approach- Here the management focuses on Industry & economic trends rather than companies. For ex- following the market trends of USA
- Bottom-up approach- Focus is mainly on company-wise trends, its financial performance and strategy. For ex- Growth investing, value investing, momentum investing and contrarian investing.
Information ratio is used to measure active management’s efficiency.
Non-transparent ETFs are a proven boon for active fund managers as they will not have to share their tactics with the end investor. It involves using Precidian’s proprietary active share model.
Advantages of Active Management
- Investors in an actively managed fund make use of the knowledge, wisdom, and experience of the fund manager.
- Active fund managers have more flexibility. There is more freedom in the selection process than in an index fund.
- Benefits in tax management are possible with actively managed funds. Managers can balance out losers with winnings because of the flexibility of buying and selling.
Disadvantages of Active Management
- Actively managed funds generally have higher fees than passively managed funds as an investor is paying for the sustained efforts of investment advisors.
- An investor considering active management should carefully examine the manager’s actual returns after fees.