Within financial markets there is a never-ending discussion between investors favouring active or passive investment management. Both management strategies main idea is to achieve the goal set out by the investor. How do they differ?
Passive management calls for holding highly diversified portfolios without spending effort or other resources attempting to improve investment performance through security analysis. Passive management usually is achieved through index funds, which replicate a specific index. This type of investing allows the investor to capture market returns at the lowest cost and possible performance fees are excluded.
Active management is the attempt to improve performance either by identifying mispriced securities or by timing the performance of broad asset classes – for example, increasing one’s commitment to stocks when one is bullish on the stock market. This management strategy provides the portfolio manager or the investor more control over its assets. As active management involves more frequent trading, security analysis and manpower, it is more expensive for the investor.
It depends on definition of “better”. Passively managed index fund is unlikely to generate excess return and higher profits compared to what can be potentially achieved through investing in actively managed fund. However, we should remember that many of actively managed funds in the end tend to underperform market indices, and at the time of initial investment it is impossible to predict, whether actively managed fund would be successful or not. From this perspective, investing in passive index fund is less risky, as such fund simply tracks performance of market index, and investor expectations are managed much better. On the other hand, passively managed index fund will keep risk level steady in both – up and down markets, hence investors in passive index funds should be ready for potentially greater volatility than investors in actively managed funds.