Introduction
In the world of investing things can seem complicated if you are not comfortable with the different terminology of mutual fund investment. Here, we’ll explore one of such terminology, Active Management in Mutual Fund.
What are Active Management in Mutual Funds?
Active management in mutual funds refers to an investment strategy where fund managers actively make decisions regarding the selection, buying, and selling of securities within the fund’s portfolio. The goal of active management is to outperform a benchmark index or achieve specific investment objectives. Unlike passive management, where fund managers aim to replicate the performance of a benchmark index, active managers rely on their expertise, research, and market analysis to identify investment opportunities and adjust the portfolio accordingly.
How active management works in mutual funds:
As the name suggests active management works in the following manner:
- Fund Manager Expertise: Professional fund managers specialise in specific sectors, industries, or asset classes, conducting thorough research and analysis to identify investment opportunities.
- Security Selection: Managers choose individual securities they believe will outperform the market, using both quantitative and qualitative factors to identify undervalued or promising investments.
- Portfolio Construction: Managers build and manage the fund’s portfolio based on its objectives and risk tolerance, actively adjusting positions to capitalise on market inefficiencies or opportunities.
- Dynamic Asset Allocation: Managers have flexibility to adjust asset allocation based on changing market conditions, tilting the portfolio towards attractive opportunities or adopting defensive strategies during volatility.
- Risk Management: Active managers actively monitor and manage portfolio risk using diversification, hedging, or position sizing techniques to control volatility and preserve capital.
- Performance Evaluation: Managers are evaluated based on their ability to outperform benchmarks or peer averages, aiming to generate alpha by outperforming while managing risk effectively.
Advantages of active management
- Potential for Outperformance: Skilled fund managers leverage their expertise and research capabilities to identify undervalued securities or capitalise on market inefficiencies, potentially leading to higher returns over the long term compared to passive strategies.
- Adaptability to Market Conditions: Active managers have the flexibility to adjust asset allocation, sector weightings, and security selection based on changing market conditions, allowing them to capitalise on opportunities and navigate different market environments more effectively.
- Risk Management: Active managers actively monitor and manage portfolio risk, seeking to mitigate downside risk while maximising potential returns. They construct diversified portfolios that are resilient to market volatility and adverse events through rigorous research and analysis.
- Specialised Expertise: Active mutual funds are managed by experienced professionals with specialised expertise in specific sectors or asset classes. They conduct in-depth research to identify opportunities, assess company fundamentals, and make informed investment decisions, providing investors with access to specialised knowledge and insights.
Disadvantages of active management
- Higher Fees: Active management typically incurs higher management fees, leading to higher expense ratios for investors, which can erode returns over time, particularly if the fund underperformed its benchmark.
- Underperformance and Lack of Consistency: Many actively managed funds fail to consistently beat their benchmark indices, resulting in underperformance relative to passive strategies, even with skilled managers.
- Manager Risk: Active management introduces manager risk, where fund performance is dependent on the skills and decisions of the fund manager. Manager turnover or declines in performance can negatively impact fund returns and investor confidence.
- Lack of Transparency: Active management can be less transparent, with fund managers not always disclosing investment decisions or portfolio holdings in real time. This lack of transparency can make it challenging for investors to understand the fund’s strategy and rationale behind portfolio change.
Who should choose active management of mutual funds?
- Investors Seeking Potential Outperformance: Prioritise potential for outperformance over benchmark indices.
- Those Valuing Professional Expertise: Appreciate guidance of skilled fund managers, benefiting from specialised knowledge and insights.
- Investors with Specialized Needs or Preferences: Seek tailored investment strategies aligned with individual goals, risk profiles, or preferences.
- Long-Term Investors with Patience: Benefit from potential alpha generation and outperformance over time, despite short-term volatility.
- Investors Comfortable with Higher Fees: Willing to pay higher management fees for potential benefits, such as alpha generation, personalized service, and specialised expertise.
Disclaimer: The views expressed here are of the author and do not reflect those of Dhanvantree. Mutual funds are subject to market risks, please read the scheme documents carefully before investing.