Active or Passive Portfolio Management, Which Style Suits Your Needs?

05-May-2011 | News-Press Release

There is a long standing debate in the investment community around actively and passively managed investment. Yet many people are not even aware of what the differences between the two types of investments are. It stands to reason that you should choose a type of investment that fits with your portfolio or serves a certain purpose.

Active Management – Active Investing Focuses on Beating the Market.  

An active fund manager will try to generate investment returns that exceed the returns for a given benchmark index. The active fund manager uses intense research and market analysis to increase their ability to find opportunities in the markets. Using available resources, the active portfolio manager selects individual shares or securities to be part of the investment basket. Active investment is based on the belief that prices react to information slowly enough to allow the investment to outperform the market. 

A typical type of actively managed portfolio is a unit trust in which investors own a portion of the fund. The selection process is generally based on specific criteria and/or the manager’s judgement, which focuses on specific securities and relies on timing of trades. Active management usually incurs higher costs that reduce returns. By choosing the right investments, taking advantage of the market trends and managing risks, active portfolio managers can generate returns that outperform a benchmark index.  

Passive Management – Passive Investing Focuses on Reducing Costs. 

A passive fund manager attempts to generate returns that match the returns of a given benchmark index. This is often referred to as index tracking or a buy and hold approach to investment management. Passive portfolio management such as ETF’s contend that it is difficult or impossible to consistently beat the market over time despite superior stock pricing and manager skill. Rather than trying to choose winners, passive investors believe that market returns are there for the taking if aligned with a buy and hold strategy for overall sectors or asset classes.    

Because passive investments like ETFs simply reflect an index, no research or market analysis is required. Trading costs also tend to be lower because fewer trades are made. In addition, fewer trades are more tax efficient. However, returns tend to be lower than the benchmark due to the costs associated with trading.

The approach of passive management is based on the concept of efficient markets, which states investors have equal access to information and therefore it is difficult to gain advantage over other investors. Therefore reducing investment costs is the key to improving returns.

Ultimately the choice of active or passive portfolio management should be determined by the investor’s personal preferences and goals. Investors should start at the end and work backwards to the beginning. By identifying goals first, the investor will have a better idea of what strategies are needed to achieve their investment goals.

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