EN
Active management means making investment decisions instead of simply following a market index. The portfolio manager studies companies, sectors, securities, market conditions, and economic factors before deciding where to invest, what to hold, and when to make changes. The approach can be used across equity, debt, and other asset classes.
In this article, you will learn what active management means, how it works, the role of a fund manager, common active investment strategies, how active management differs from passive investing, and the benefits and risks involved.
Key Takeaways
- Active management involves investment decisions based on research, analysis, and the manager's investment view.
- The objective may be to outperform a benchmark or achieve the scheme's stated investment objective.
- Active managers can change portfolio holdings and allocations based on their assessment of market conditions.
- Fundamental research is commonly used to assess companies and securities.
- Active management can be used in both equity and debt investments.
What is Active Management?
Active management is an investment approach where a portfolio manager or team actively selects, allocates, and adjusts securities rather than passively replicating an index. Every decision is grounded in detailed research, analysis, and risk management.
Key Responsibilities of an Active Fund Manager
Rather than following a fixed index, the fund manager makes strategic choices within the scheme’s mandate:
- Security Selection & Allocation: Deciding which stocks, bonds, or assets to buy or sell, and determining exact position sizes to balance returns against concentration risk.
- Sector & Asset Weighting: Overweighting promising sectors or undervalued companies while underweighting or selling expensive ones.
- Cash & Portfolio Timing: Adjusting cash levels and shifting allocations based on evolving market and macroeconomic conditions.
Fundamental & Quantitative Research:
- Equity: Analyzing financial statements, evaluating earnings potential, studying industry trends, and assessing company management.
- Debt/Fixed Income: Evaluating credit quality, interest rate movements, maturity profiles, and duration.
Active Management in Equity Investments
In equity investing, active managers generally try to identify stocks that they believe can generate attractive returns relative to their risk.
A manager may look at:
- Revenue and earnings growth
- Profit margins
- Cash flows
- Debt levels
- Competitive position
- Management quality
- Industry conditions
- Valuation
- Future growth prospects
The manager may then build a portfolio based on the stocks that best fit the investment strategy.
The portfolio does not have to exactly match the benchmark.
For instance, if the benchmark has a 5% allocation to a particular company, an active fund could hold 8%, 2%, or none of that company's shares, depending on the scheme's mandate and the manager's investment view.
Active Management in Debt Investments
Active management is also used in fixed-income portfolios. A debt fund manager may make decisions based on:
- Interest-rate expectations
- Credit quality
- Yield
- Maturity
- Duration
- Liquidity
- Economic conditions
- Changes in the credit outlook
Suppose a manager expects interest rates to decline. The portfolio may be positioned differently from a benchmark to benefit from the expected change, subject to the scheme's mandate.
Active Management vs Passive Management
|
Feature |
Active Management |
Passive Management |
|
Investment approach |
Manager makes investment decisions |
Portfolio follows an index or benchmark |
|
Security selection |
Based on research and investment views |
Based primarily on index constituents and rules |
|
Portfolio changes |
Can be made based on the manager's assessment |
Usually made when the underlying index changes |
|
Objective |
May seek to outperform a benchmark or meet a specific objective |
Generally seeks to replicate the benchmark's performance |
|
Fund manager discretion |
Higher |
Lower |
|
Portfolio difference from benchmark |
Can be significant |
Usually limited |
|
Costs |
Can be higher because of active research and management |
Generally lower, although costs vary |
|
Performance |
Can outperform or underperform the benchmark |
Returns generally differ from the benchmark because of costs and tracking difference |
Why do Investors use Active Management?
1. Opportunity to outperform
One of the main reasons investors choose active management is the potential to earn returns above the benchmark. The manager can take positions that differ from the index when the investment team identifies an opportunity.
2. Ability to respond to changing conditions
An active portfolio can be adjusted when market or economic conditions change. A manager can reduce exposure to a particular company or sector if the investment case changes.
3. Focus on specific opportunities
An active manager does not have to own every security in an index. The portfolio can focus on investments that align with the fund's strategy.
4. Risk management
An active manager can make portfolio decisions with risk in mind. This does not eliminate investment risk, but it can influence the portfolio's risk profile.
What are the Limitations of Active Management?
1. Higher costs
Active funds generally involve research, analysis and portfolio management.
These activities can result in higher expenses compared with some passive investment products. The expense ratio therefore becomes an important factor when comparing actively managed funds.
2. Manager risk
The quality of investment decisions depends partly on the fund manager and investment team. A change in the manager or investment process can affect how the portfolio is managed.
3. Benchmark underperformance
An active fund may fail to outperform its benchmark. It can also underperform the benchmark for extended periods.
4. Investment style can go through difficult periods
A particular investment style may work well in one market environment but struggle in another. For example, a value-oriented strategy may behave differently from a growth-oriented strategy when market leadership changes.
5. Higher portfolio turnover
Some active strategies involve frequent buying and selling. Higher turnover can increase transaction-related costs and may affect the fund's overall expenses and performance.
How to Evaluate an Actively Managed Fund
When assessing an active fund, look beyond its return:
-
Investment objective: Understand what the scheme is designed to achieve.
-
Portfolio: Check the major holdings, sector allocation, market-cap exposure and concentration.
-
Benchmark: Compare performance with the appropriate benchmark.
-
Long-term performance: Look at several periods rather than only the most recent return.
-
Risk: Review the Riskometer along with measures such as volatility and portfolio concentration.
-
Expense ratio: Higher costs can reduce the portion of investment returns retained by the investor.
-
Fund manager: Check the manager's experience and investment approach.
-
Investment style: Understand whether the fund follows a growth, value, quality, contrarian or another strategy.
-
Portfolio turnover: A high turnover can provide insight into how actively the portfolio is being changed.
-
Consistency: Look at how the fund behaved across different market conditions. A fund that performs well only during one type of market environment may have a very different risk-return profile from one that has remained relatively consistent.
Is Active Management Risky?
Not necessarily. Active management refers to how investment decisions are made, not to a specific level of risk.
An actively managed large-cap fund and an actively managed small-cap fund can have very different risk profiles. The underlying securities, investment mandate, portfolio concentration and strategy matter.
The same applies to debt funds. An actively managed debt fund investing in high-quality, short-duration securities may have a very different risk profile from one that takes significant credit or duration exposure.
Conclusion
Active management is about making investment decisions rather than simply replicating an index. This approach gives a portfolio greater flexibility and the potential to outperform a benchmark. At the same time, active management can involve higher costs, manager risk and the possibility of underperformance.
