Active Management: Role & Investment Insights

Different investors have different ways of growing their money. While some prefer a passive approach allowing the market to work for them, others prefer actively managing their investment and conducting thorough research and analysis.

Here, the second approach is termed as ‘active management’.

In this article, we will learn about active management, how it works, its main strategies and its pros and cons. We will also compare it with passive management to give you a clear understanding. So, let’s begin.

• Table of contents

• Understanding active management in investment
• Process of active management
• Top 3 strategies of active management
• Active vs. passive management
• Advantages of active management
• Disadvantages of active management

Understanding active management in investment

To simplify, active management in investment is an approach where fund managers or investors make specific investments with the goal of beating a benchmark index. So, instead of just copying a market index like the Nifty 50 BSE 500, active investors or mutual fund managers use research, forecasts and their judgment to decide which securities to buy, hold or sell.

Also Read: Private equity funds explained

Process of active management

Planning

In this step, the investor's goals and limits are identified. This includes understanding how much risk they are willing to take, what returns they expect, how quickly they might need the money, how long they plan to invest, and any tax or legal rules they must follow. Based on this, an Investment Policy Statement (IPS) is made. The IPS includes things like reporting requirements, rebalancing guidelines, investment communication, manager fees and investment strategy and style.

Next, active managers predict how markets will perform and estimate the risk and return of different investments. Then, they decide how much money should go into each type of investment which is called strategic asset allocation.

Execution

Here, the actual investing happens. Active managers use their strategies and market predictions to pick specific investments for the portfolio. They aim to combine different assets efficiently so that the portfolio meets the return goals without taking on unacceptable risk.

Feedback

In the feedback step, the portfolio is regularly checked and managed. Managers rebalance the portfolio to keep it aligned with the IPS rules. Investors also review the portfolio’s performance from time to time to make sure it’s still helping them reach their financial goals.

Top 3 strategies of active management

Stock picking

This is one of the most common strategies. Fund managers usually do a lot of research, using both company data and market trends, to pick the most suitable stocks for their portfolio. If they find a stock that's priced lower than it should be, they buy it and wait for its value to go up. If they find a stock that's priced too high, they might sell it early, hoping to buy it back later at a lower price and make a profit.

Market timing and investment focus

This strategy involves predicting market movements. Managers decide the suitable times to enter or exit the market based on economic indicators, political events or market trends. For example, if a manager predicts a recession, they might shift investments from stocks to relatively stable assets like bonds.

Sector rotation

In this strategy, managers move investments from one sector to another based on expected performance. For instance, if they believe the tech sector will grow faster than the energy sector, they might allocate more funds to tech companies.

Active vs. passive management

Active management tries to earn relatively better returns by carefully choosing investments, while passive management simply tries to match the performance of a market index. In passive management, the fund invests in the same stocks as the index, which usually costs less but doesn’t aim for bigger profits.

On the other hand, active management is more involved. Fund managers make changes based on market trends and try to pick investments that could beat the index. But how well active management works depends a lot on the fund manager’s skills and the overall market situation.

Advantages of active management

• Potential for returns: Skilled managers can outperform the market and generate greater wealth.
• Flexibility: Managers can quickly adapt to market changes and invest in opportunities that arise.
• Risk management: Active managers can move assets away from sectors or stocks they believe are going to decline.

Disadvantages of active management

• Higher costs: Management fees, research expenses and frequent trading can lead to higher costs.
• Market risk: Even skilled managers can make wrong predictions.
• Underperformance: Many active funds fail to beat their benchmarks consistently.

Also Read: Investment strategies for different life stages

Conclusion

Active management is a dynamic investment approach that aims to outperform market indices through constant monitoring, research and decision-making. It can offer rewards but also comes with higher risks and costs. Choosing between active and passive management largely depends on an investor's financial goals, risk appetite and belief in the skills of fund manager.

FAQs:

What is the meaning of active management?

Active management refers to an investment strategy where fund managers make specific investment decisions with the aim of outperforming a market benchmark.

What is considered active management?

Active management is considered to be any approach where a fund manager or investor is actively involved in making decisions about what to buy or sell––instead of passively following a benchmark index.

What is the aim of active management?

The main aim of active management is to achieve relatively better returns than a specific market index or benchmark.

What is active management or passive management?

Active management and passive management are two different investment styles. Active management involves active decision-making to outperform the market, while passive management involves investing in a way that mirrors a market index without trying to beat it.