Active management
Categories: Economics and finance stubs | Funds
Active management refers to a portfolio management strategy where the manager makes specific investments with the goal of outperforming a benchmark index. Ideally, the manager selects securities that expose the portfolio to more risk than its index. If the additional risk generates excess return, the active management strategy has succeeded.
The reality of active management is as follows: majority of actively manage mutual funds, ETF,etc. very rarely outperform thier index counterparts (assuming that it is benchmark correctly), and when successful only usually by a few percerage points. Even if successful the odds of beating the market decreases as time progress. When all expenses are taken into account one might actually see a negative ROR even if the security outperform the Market. However if it was not for active management, passive management will become a crapshoot, thus the incentives for active managment will aways exist.
Active management is the opposite of passive management, where the manager does not seek to outperform his index.
Real active management
Equity fund managers usually don't have board members at the firms they have an equity stake, and they do virtually nothing about the future performance of the firm. So buying and selling equity is not active management of the companies, its just an active transaction of equity in the fund.
The selection process of fund managers is a combination of ratio picks: P/E ratios, PEG ratios, sector pics: "I think oil will do well in the next years because oil is used to make gas", and "I like small cap", and lastly the "Eeny, Meeny, Miny, Moe" method of random selection.
Real active management is done by the people that work at the company, every employee and manager. Private-equity is often real active management since a privately owned company have a small number of owners and usually have just one owner that make strategy decisions at the board level.
The profitability of active management is summarize by William F. Sharpe, intitle "The Arithmetic of Active Management" [1].
See also