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What is Active Management?

Active management is an approach to investing. In an actively managed portfolio of investments, the investor selects the investments that make up the portfolio. Active management is often compared to passive management or index investing.

Active investors use several different techniques to choose investments. The two most common techniques are:

  • Fundamental research. Some active investors make their selections by using research on the characteristics of individual investments to evaluate their risk and potential return.
  • Quantitative investing. Some active investors define a systematic process to select investments using data about the individual investment.

When selecting investments, active managers may also consider how an individual investment will affect the characteristics of the portfolio as whole.

Active management is used in all aspects of investing. For example, an investor can use active management for:

  • Security selection. Selecting stocks, bonds, or other investments.
  • Asset allocation. Active management can help determine the allocation of portfolio assets among cash, bonds, stocks, real estate, and other asset categories.
  • Sustainability analysis. Active management is an essential element in the assessment of environmental, social, and governance factors.

Active management is the dominant approach to investing.

This short video from the Active Managers Council explains the foundation of active management and the differences between active and passive, highlighting how active management can benefit investors at-large.

How Does Active Management Compare to Passive Management?

Active management is often compared to passive management, which is sometimes called index investing. In passive management, the investor selects investments because they are included in an index.

Active and passive management are often combined in the management of a portfolio. For example:

  • An investor pursues active strategic asset allocation among asset types (such as cash, bonds, and stocks), but invests in each asset class using index funds.
  • An active manager uses an index as a reference point for assessing performance or risk in an actively managed stock fund.
  • An investor selects only investments that are included in a specific index, but exclude an investment based on research into the sustainability of the company behind the investment.
  • An investor makes an active decision to invest in a passively managed portfolio based on a particular index.

In addition, the construction of an index involves active decision-making about the appropriate investments to include in the index.

Why Should Investors Consider Active Management?

Active management provides investors the opportunity to earn superior returns through astute selection of investments.

Active management also enables investors to customize portfolios. For example, active management can:

  • Help an investor manage risk, by adjusting portfolio investments to reflect the investor’s risk tolerance.
  • Focus on investments that generate dividend or interest income, if an investor seeks a steadier income flow.
  • Support implementation of an investor’s tax plan.
  • Identify investments that advance an investor’s mission-based goals. For example, an investor may wish to support companies that advance diversity in employment, even if investments in those companies are not the ones with the highest expected financial return in the short term.

Active management is essential for:

  • Certain types of investments, such as ESG or sustainable investing
  • Certain asset classes, such as private equity or venture capital and other alternative investments

On the other hand, compared to passive management, active management generally involves greater costs. Active managers must pay for the resources needed to identify investments through fundamental research, quantitative investing, or other active management approaches. As a result, the fees charged by active managers are generally higher than those charged by passive managers. In addition, while active management has the potential to generate superior returns, it may not do so consistently. There is considerable debate about whether the results achieved by active management outweigh the higher costs involved.

However, recent research suggests that active management provides a reasonable combination of return and cost.

What Role Does Active Management Play in the Markets?

Active management plays an important role in maintaining market efficiency. In an efficient market, on average, the prices of securities reflect the value of the assets underlying the securities. In addition, in an efficient market, the prices of over- or undervalued securities tend to move toward fair value, rather than further away from it, and prices adjust quickly to changes in value. New information is the primary driver of price change in efficient markets.

More efficient markets have three principal advantages:

  • They encourage broader investor participation.
  • They make it easier to diversify risk.
  • They encourage capital formation.

On the other hand, market inefficiency leads to inefficient decision-making in the real economy which depresses economic growth.

Active management is the driver of market efficiency. Through the buying and selling of investments, active managers establish the market prices for securities. Therefore, an increase in the amount of active management will lead to greater market efficiency.

Actively managed portfolios are also critical to capital formation, since they are buyers of initial public offerings of securities issued by private companies.

All investors benefit from the efforts of active managers.

“Active Investing and the Efficiency of Security Markets” by Russ Wermers, an award-winning research paper sponsored by the Active Managers Council, discusses the relationship between active management and market efficiency.

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