Active management

Definition

Active management is an investment strategy where a manager or team of managers makes decisions about the buying and selling of securities in an effort to outperform a specific benchmark index. This approach involves continuous analysis, research, and the ability to make timely trades, as opposed to passive management, which involves holding investments for the long term without frequent trading. Active management is often used in mutual funds and exchange-traded funds (ETFs) to try and achieve higher returns than what the market might provide.

5 Must Know Facts For Your Next Test

1. Active management generally incurs higher fees compared to passive management due to the costs associated with research and frequent trading.
2. The goal of active management is to achieve returns that exceed those of a benchmark index, which can potentially lead to higher rewards but also comes with increased risk.
3. Active managers rely on various analysis techniques, including fundamental analysis and technical analysis, to make informed decisions about which securities to buy or sell.
4. Research suggests that while some actively managed funds outperform their benchmarks, many do not, leading investors to consider whether the higher costs are justified.
5. Active management can offer more flexibility in responding to market changes compared to passive management, which may be advantageous in volatile market conditions.

Review Questions

• How does active management differ from passive management in terms of investment strategy and objectives?
  • Active management focuses on making specific investment decisions to outperform a benchmark index through research and timely trades. In contrast, passive management aims to replicate the performance of a benchmark by holding investments long-term without frequent trading. The objective of active management is to generate higher returns than the market average, while passive management generally seeks to match market performance.
• What are some of the advantages and disadvantages of utilizing active management strategies within mutual funds and ETFs?
  • The advantages of active management include the potential for higher returns through strategic buying and selling based on market analysis. However, disadvantages include higher fees associated with active trading and the risk that many actively managed funds may not outperform their benchmarks after costs are accounted for. These factors make it essential for investors to weigh the potential benefits against the costs when choosing funds.
• Evaluate how market conditions influence the effectiveness of active management strategies in mutual funds and ETFs.
  • Market conditions play a significant role in determining the effectiveness of active management strategies. In volatile or rapidly changing markets, skilled managers may capitalize on short-term opportunities that allow for significant outperformance compared to benchmarks. Conversely, during stable or trending markets, it may be challenging for active managers to consistently outperform passive strategies due to lower price fluctuations and limited opportunities. Thus, understanding market dynamics is crucial for assessing when active management could be more beneficial.

Related terms

passive management: An investment strategy that aims to match the performance of a benchmark index by investing in the same securities as that index, rather than trying to outperform it.

benchmark index: A standard against which the performance of an investment or portfolio can be measured, often used in assessing the effectiveness of active management.

fund manager: A professional responsible for making investment decisions for a mutual fund or ETF, including those using active management strategies.