Passive management

Key Takeaways

1. Passive management is the strategy of an investment fund of following a benchmark index to replicate the performance of the index or the broader market.
2. Active management focuses on outperforming the market. And passive management mimics the performance of a specific index to achieve the maximum profit.
3. In passive management, portfolio implementation is done in two ways: replication basis and sampling.

Passive management is the strategy of an investment fund of following a benchmark index to replicate the performance of the index or the broader market. 

The fund is made up of a way to mimic the index it wants to follow. The investor’s money does not underperform or outperform the index but gives returns similar to what the benchmark achieves. 

Example

ETFs are passively managed funds.

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Human intervention in passive management is minimal, and there is no active steering of securities to invest the pooled investor money in. At the time of investing, the client can see the makeup of the fund’s underlying assets as it comes with the clear mandate of replicating benchmark returns.

Passive Management

Passive management is generally referred to as passive strategy, passive investing, or index investing. The core fundamental of passive management is to track a specific index like Nifty 50 etc.

About Passive Management

Passive management is the strategy of an investment fund of following a benchmark index to replicate the performance of the index or the broader market. The fund is made up of a way to mimic the index it wants to follow. The investor’s money does not underperform or outperform the index but gives returns similar to what the benchmark achieves.

Passive management tries to replicate the market index, whereas active management tries to outperform the market. Passive management is referring to management, which is associated with exchange-traded funds and mutual funds. Passive management helps the investor to maintain a diversified portfolio, has a low transaction cost and low management costs. Because of these benefits, an investor would earn higher profits in such funds than in other identical funds, which have higher management costs and low-cost investment with a well-diversified approach.

Efficient market hypothesis or EMH is a theory which states that all securities are reasonably priced, and the price reflects (or it anticipates) the present, past, and future information, both publicly and privately available in the market. The theory requires information about factors affecting security to be quickly made available. Passive management of investments hinges on EMH and believes the markets are challenging to beat as information about a security is equally open to all, while active management believes in inefficient markets which belies information, and hence active human intervention can unlock alpha (i.e., achieve abnormal returns) based on previously unknown information for leverage.

How does passive management work?

Active management, the portfolio manager simply tries to beat the market. In the active management, the implementation is done by stock picking. It means that the portfolio manager lookout for multiple companies, meets with the management of the company, tries to make a judgment, what will be the growth strategy of the company, how a company will perform in the future, tries to assess companies profitability and on that basis, they make the decision, which stocks are suitable for their portfolio framework and do individual stock by stock picking.

In passive management, the key concept of implementing the portfolio is mainly in 2 ways. One is the replication basis entire index, or the particular portfolio is replicated with what underlying weightage is. In certain cases, it is not easy to access the whole basket of all securities. At that time, optimization or sampling approaches are used. The entire security basket is selected, which will ensure as close as possible, risk, and return objective of the basket.

Why does Passive Management matter?

Many investors think of passive management as a plausible concept because it is not possible to outperform the market every time. So, to ensure maximum return, the investors prefer passive management. In the long-term investment, an average investor benefits more by reducing the management cost than by beating the market average. It does not matter Which specific security is chosen or selected, but how well the portfolio is diversified is the most important when it comes to an investment. It affects the portfolio’s overall return as many assets tend to fall or rise.

Difference between Active Management and Passive Management

Active Management and Passive Management these are two strategies mainly used by the investors to gain a return on their investment account. Active management focuses on outperforming the market. And passive management mimics the performance of a specific index to achieve the maximum profit. Active management generates higher returns, but for this, the investor must be ready to take some higher risk and should be ready to pay higher management fees.