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Passive Management Essay

2100 words - 9 pages

WHAT IS ACTIVE MANAGEMENT?
 
Active management might best be described as an attempt to apply human intelligence to find "good deals" in the financial markets. Active management is the predominant model for investment strategy today. Active managers try to pick attractive stocks, bonds, mutual funds, time when to move into or out of markets or market sectors, and place leveraged bets on the future direction of securities and markets with options, futures, and other derivatives. Their objective is to make a profit, and, often without intention, to do better than they would have done if they simply accepted average market returns. In pursuing their objectives, active managers search out ...view middle of the document...

These include trading costs, much higher management fees, market impact costs as active managers affect the prices they pay, dilution from maintaining higher cash positions than passive managers, taxes in taxable accounts due to high turnover rates, and, commissions, if an investment "product", like a mutual fund, is purchased through a broker or financial salesperson. These costs create a handicap for the active investor of about 2% to 10% per year, depending upon asset class mix, and whether a salesperson is involved. The least expensive forms of active management, no-load mutual funds and "wrap fee" accounts, typically consume 1.3%-2.5% per year of an investor's returns, while the average passive or index portfolio runs under 0.4% per year. 
Passive management (also called passive investing) is a financial strategy in which an investor (or a fund manager) invests in accordance with a pre-determined strategy that doesn't entail any forecasting (e.g., any use of market timing or stock picking would not qualify as passive management). The idea is to minimize investing fees and to avoid the adverse consequences of failing to correctly anticipate the future. The most popular method is to mimic the performance of an externally specified index. Retail investors typically do this by buying one or more 'index funds'. By tracking an index, an investment portfolio typically gets good diversification, low turnover (good for keeping down internaltransaction costs), and extremely low management fees. With low management fees, an investor in such a fund would have higher returns than a similar fund with similar investments but higher management fees and/or turnover/transaction costs.[1][2]
Passive management is most common on the equity market, where index funds track a stock market index, but it is becoming more common in other investment types, includingbonds, commodities and hedge funds.[3] Today, there is a plethora of market indices in the world, and thousands of different index funds tracking many of them.[1]
One of the largest equity mutual funds, the Vanguard 500, is a passive management fund.[3] The two firms with the largest amounts of money under management, Barclays Global Investors and State Street Corp., primarily engage in passive management strategies.[3]
Active management (also called active investing) refers to a portfolio management strategy where the manager makes specific investments with the goal of outperforming an investment benchmark index. In passive management, investors expect a return that closely replicates the investment weighting and returns of a benchmark index and will often invest in an index fund.
deally, the active manager exploits market inefficiencies by purchasing securities (stocks etc.) that are undervalued or by short selling securities that are overvalued. Either of these methods may be used alone or in combination. Depending on the goals of the specific investment portfolio, hedge fund or mutual fund, active...

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