Active Portfolio Management Strategy refers to a portfolio management strategy that involves making precise investments for outperforming an investment benchmark index. The portfolio manager that follows the active management strategy exploits the market inefficiencies by buying undervalued securities or by short selling overvalued securities. Any of these procedures can be used alone or in combination.
Active portfolio managers may create less volatility (or risk) than the benchmark index depending on the targets of the specific hedge fund or mutual fund or investment portfolio. The risk reduction is considered as goal of creating an investment return larger than the benchmark. They use large number of factors and strategies for constructing their portfolio.
Strategies for Constructing the Portfolio
· Quantitative measures like price/earnings ratio (P/E ratios) and PEG ratios
· Sector investments that are expected to deliver long-term macroeconomic trends
· Buying stocks of companies that are disliked temporarily
· Selling at a discount of their intrinsic value
· Merger arbitrage
· Short positions
· Option writing
· Asset allocation
The performance of an actively-managed investment portfolio relies on the proficiency of the portfolio manager and research staff. There are many mutual funds that are supposed to be actively managed and they stay invested irrespective of market conditions along with only negligible adjustments in allocation over time. In conditions of prolonged market declines, the managers may use hedging strategies. The performance characteristics are different with two groups of active managers.
Benefits of Active Management
· The active portfolio management strategy allows the portfolio managers to select a variety of investments rather than investing in the market as a whole. There may be different kinds of motivations for the investors to follow active management strategy.
· In order to generate profits, the investors consider that some market segments are less efficient than others.
· Portfolio Manager may manage the volatility or risks of market by investing in less-risky and high-quality companies instead of investing in market as a whole.
· Investors may take additional risk for achieving higher-than-market returns.
· Those investments which are not vastly correlated to the market function as portfolio diversifier and decrease the portfolio volatility as a whole.
· Investors may follow a strategy for avoiding certain industries in comparison to the market as a whole.
· Investors that follow actively-managed fund are more aligned for achieving their specific investment goals.
Drawbacks of Active Management
· There are chances of bad investment choices to be made by fund manager
· Fund Manager may follow an unsafe theory for the management of the portfolio
· The costs related to the active management are higher in comparison to passive management in case of lack of frequent trading
· Fund managers should actively evaluate the fund’s prospectus before investing in an actively-managed mutual fund because most of the actively-managed large and mid-cap stock funds fail to beat or outperform their passively managed counterparts.
· Higher transaction costs results due to frequent trading with active fund management strategies that reduces the fund’s return.
· The short-term capital gains due to frequent trading have an unfavourable income tax impact.