With the investment market in India, there are two ways in which the money and portfolio can be managed. Depending upon how actively you are involved in your portfolio, there are two strategies that you can employ to manage your funds- Active Management and Passive Management.
In a nutshell, active portfolio management is one that is focused on outperforming the concerning benchmark in the investment market whereas passive portfolio management is one that follows the related index with a laid-back approach and does not focus much on outperforming the benchmark.
Passive management is essentially replicating the index against which it is benchmarked. This article covers the differences in detail and more. Read On!
In this article
- What is active management of an investment portfolio?
- What is passive management of an investment portfolio?
- Active and passive investment portfolio management: Pros and Cons
- How to choose between active management and passive management?
What is active management of an investment portfolio?
When an investor is actively involved in managing the funds in such a manner that they outperforming the index against which they are the benchmark with the help of brokers, fund managers, and other intermediaries, it is called active portfolio management.
Active management involves excessive buying and selling of funds which are collectively aimed towards beating the market. All attempts are aimed towards gaining more than the set benchmark while the markets are flourishing and be at a comparatively lesser loss while the market is down. All this is done by juggling between fund types.
Active management of funds involves a team of experts led by a fund manager, co-managers, and other financial experts who keep making relevant investment decisions from time to time for your portfolio depending upon the market conditions.
No single aspect can ensure the success of your portfolio until it is backed by a rich experience of the fund manager and his team, in-depth research of the subject matter (in this case the target funds and companies) and on-point market forecasting by keeping a vigilant eye on the market movements.
Not just market movements but the economy are also analyzed deeply along with any political changes and other influencing factors enjoying a stronghold over the financial market. The analysis is done so as to pinpoint any irregularities and mismatches which can prove beneficial for your investments.
As per active management supporters, this is a better method of portfolio management since it involves going by logic and numbers towards your future wealth and ensures a multi-fold rise in the money as compared to passive investing.
The only thing which needs to be kept in mind while managing the portfolio actively is that it involves taking a lot of risk in the market while making a stock selection and pushing money into it.
Also, since a dedicated fund manager along with his team will be working hard towards the exponential success of your portfolio, it obviously calls for consultation fees to be paid to them. this fee is called expense ratio which is taken from the investor and comes inherent with active portfolio management.
What is passive management of an investment portfolio?
Index fund management or passive management of the investment portfolio is a management type that is more laid back as compared to active portfolio management and aims towards mimicking the index it is benchmarked against. The idea is to stay as close to the index benchmark fund as possible to generate similar returns.
The managers simply replicate the benchmark investment in securities that the benchmark fund makes and aim towards gaining similar to the benchmark’s returns rather than outperforming it.
Passive portfolio management does not require any dedicated team of experts since it is an almost one-time thing to invest in the securities which replicate the benchmark or index and wait for the returns to be generated.
Passive funds can be categorized into mutual funds, exchange-traded funds or unit investment trusts. These funds are known as passive funds due to the nature of their management where the manager is not required to stay on toes over the market movements and make alterations in the portfolio accordingly. Just the replication of index is required to be done which does not require any heritage of experience or knowledge of market movements and corrections and troubleshooting them for the best benefits.
Due to the management style being reactive and not proactive like active funds, there is no or minimal consultation fee as charged by the fund houses and managers for portfolio management. These funds are best for people with low-risk tolerance and are of the conservative type when it comes to investing.
Active and passive investment portfolio management: Pros and Cons
Let us see the pros and cons of each management technique to differentiate them better.
Active management pros
The biggest advantage of going for the active management of the portfolio is that it brings along the experience of the fund manager who can apply the best of his skills and ensure greater alpha and returns to you. active funds come with greater tax benefits and can also help you increase your post-tax returns by selling off the ones which are underperforming, hence accounting for losses. Active management also gives the fund manager a buffer to experiment within the risk appetite of the investor to generate returns which are exponentially greater.
Active management cons
With all these advantages, there is a lot of risks associated with active portfolio management. Moreover, these are funds are quite expensive as compared to index funds and the cost is borne by the investor. The issue is not limited to the cost, most people are ready to pay a little extra for noticeable returns but fund managers have lately disappointed investors by being unable to outperform the index or benchmark which is the essence of active management.
Passive management pros
Passive management on the other is low-key in terms of cost and maintenance. This is essentially a long-term approach that aims towards gathering gradual wealth over the due course of investing. This is a great investment avenue for small investors who can stay invested and eventually patient over the long term. Another advantage of passive investing is that there is complete transparency in the process since the indices are mapped and investments are made, no other alterations to the portfolio are done.
Passive management cons
The only and biggest disadvantage with passive management is the limit of choice with this style. Especially in India, there are very limited options available to a passive investor which makes passive funds form only a tiny part of the total investments in the country.
How to choose between active management and passive management?
While making this decision can be a lot confusing and under detailed, here are few things you must consider before making a decision regarding the investment strategy.
- What is your expectation as an investor?
First things first, you as an investor must know what are you looking for. Do you expect high returns with some risk over short to medium-term or you want a risk-free long-term investment avenue that generates decent returns? You can go for active investing in former and passive investing in the latter case.
- What is the market offering?
If the markets are offering high alpha, active management is your call and if it is not the case then you can go for passive investing. If you are locating more of macros, passive is your call.
- Do you prefer a safe and diversified approach or a concentrated one?
Passive investing is more about a safe approach towards a diversified portfolio while active investing accounts for a concentrated approach especially in equities to outperform the benchmark in terms of returns within a given period.
- Are you looking forward to a balanced approach?
The most important aspect of investment portfolio management is that you are not restricted to one type. This is not a pick one game; you can always go for a mix of both with different investments across each. A mix of both active and passive strategies will ensure stability and balance in your portfolio hence meeting your return and risk requirements.
Active or passive, you must possess a basic understanding of the ideology behind these investment styles which can prove to be a turning point in your history of being invested. While active management comes loaded with the experience of a fund manager, there are always some risks associated with it and the consultation does not come for free. On the other hand, in the passive style of management, the growth is gradual and takes its own good time. Whatever choice you make, be sure of the fact that it falls in alignment with your financial goals.
Disclaimer: The views expressed in this post are that of the author and not Groww