A guide to the different types of portfolio management

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Investing in today’s financial markets requires meticulous planning and well-considered decision-making.

Different types of portfolio management each play a key crucial role in managing risk while maximising potential investment returns. By employing effective investment strategies and diversifying investments, leading portfolio managers work to achieve the financial goals of their clients, whether they are companies or individuals. Understanding these techniques can help you make more informed investment decisions, regardless of your investing experience.

In this article, we will take an in-depth look at the four main types of portfolio management – active, passive, discretionary and non-discretionary – along with their unique characteristics.

What is portfolio management?

Portfolio management is defined as the process of managing a wide range of investments to reach set financial goals.

It is widely regarded as a crucial element of both investment and financial planning, and involves strategically managing a collection of investments, called a portfolio. These different investments are managed with the aim of achieving specified financial objectives while simultaneously balancing returns against risk.

Portfolio management typically involves selecting and allocating assets, but also monitoring their performance within a portfolio. The main aim of every portfolio manager is to optimise potential returns while considering the investor’s attitude towards risk, investment goals and time horizon.

Understanding the different types of portfolio management

While there are a wide range of portfolio management strategies practiced, four main types see prevalent use today. Below, we will explore the characteristics, aims and methodologies that differentiate them from one and other.

Active Portfolio Management

A dynamic approach to investing, active portfolio management involves operational investment decisions made with the aim of outperforming the financial market.

This management style requires expert portfolio managers who carry out in-depth research and analyse market trends, before actively selecting and managing investments with the objective of obtaining superior returns. However, there are both pros and cons to active portfolio management.

The main advantage of active portfolio is its potential to achieve above-average returns. Skilled active portfolio managers identify mispriced assets and take advantage of short-term opportunities on the market, providing the potential for generating higher returns.

An active approach is also flexible and adaptable. Agile managers can adjust the asset allocation of a portfolio, but also its holdings and sector weightings according to sudden investment opportunities, shifting economic outlooks and fluctuating market conditions.

Active managers also work to outperform the market index, which potentially allows investors to achieve higher-than-average returns.

The disadvantages of active portfolio management include higher costs than other strategies for management fees, research expenses and transaction fees. The risk of underperformance is also present when active managers fail to outperform the financial market. Active trading also can lead to higher portfolio turnover, resulting in market impact and increased capital gains taxes and transaction costs.

Passive Portfolio Management

Sometimes referred to as index investing, passive portfolio management is an approach that seeks to mirror the performance of a specific market index, instead of trying to actively outperform the financial market.

Passive managers set up portfolios that closely replicate the weighting and composition of their chosen index. However, passive portfolio management also has pros and cons as an investment approach.

The most attractive feature of passive management is that it usually involves lower costs in comparison to an active strategy. As passive portfolio managers aim to mirror an index, they have far lower trading and research expenses. Furthermore, index funds typically have lower expense ratios.

Passive managers supply their clients with exposure to an entire sector or market by replicating the market index. This broader market exposure empowers investors to diversify portfolio holdings across a wider range of securities, which reduces the effect of individual stock performance on their overall investment portfolio.

A consistent and simple strategy, passive management uses a rules-based systematic approach. As a result, investors can anticipate consistent performance aligned with the index, and the investment strategy is usually relatively straightforward to implement and understand.

The downside of passive portfolio management is its limited potential to outperform the market. It doesn’t aim to outperform the index, and can miss out on opportunities for higher returns that active managers can capture by making tactical decisions, and picking undervalued assets.

Passive managers never actively adjust portfolios based on financial forecasts or market conditions. As a result, passive portfolios can be fully exposed to severe market downturns, and don’t benefit from the risk management strategies used by active portfolio managers.

Passive investment portfolios are limited in terms of customisation and flexibility. Investors must keep within the weightings and composition of the index, restricting how they align their portfolio with specific investment goals and personal preferences.

Discretionary Portfolio Management

An expert investment service supplied by portfolio managers and wealth managers, discretionary portfolio management involves investment professionals making decisions on behalf of their clients. The portfolio managers can sell, buy and alter the portfolio without acquiring explicit consent for every transaction. However, like all portfolio management types, discretionary portfolio management has its pros and cons, and suits specific types of investors.

The core advantage of discretionary portfolio management is the time it saves. The delegation of investment decision-making to a discretionary portfolio manager helps investors save effort and time required for monitoring, research and making decisions. This enables investors to instead focus on other parts of their lives, while having their investment portfolio managed by professionals.

In discretionary management, a relationship of trust between the portfolio manager and their client is crucial, and when successful, can provide premier levels of peace of mind.

Discretionary managers build portfolios based on their client’s individual investment goals, preference and risk tolerance. This personalisation ensures that investment portfolios are always aligned with the investor’s objectives and needs.

As portfolios are continuously monitored, discretionary managers can make timely adjustments according to emerging market opportunities and changing conditions. This dynamic active management approach provides the potential to benefit from market upswings and limit risks during sudden downturns.

Lack of control is the key disadvantage of discretionary management. Investors have less direct involvement and control regarding investment decisions. This makes it unsuitable for investors who prefer a hands-on approach.

For investors who wish to be actively involved in investment decision-making, discretionary management can limit the potential for learning opportunities that comes with researching and analysing before making independent investment choices. As a result, investors who find value in this learning process may prefer a portfolio management type where they retain control over some investment decisions.

Non-discretionary Portfolio Management

An investment approach that involves portfolio managers providing investment advice and expert recommendations to clients, non-discretionary portfolio management puts the authority for final decision-making with the clients themselves.

In this type of portfolio management, investors retain total control over their own investment decisions and must supply explicit consent before each transaction can take place. Non-discretionary portfolio management has both its advantages and disadvantages, however.

A major benefit of non-discretionary portfolio management is the control it offers clients, as it allows investors to take charge of their investment decisions. After receiving the advice and recommendation of the portfolio manager, investors always have the final say on whether it is implemented, giving them a greater sense of ownership and involvement in the investment process.

Non-discretionary managers also provide bespoke investment advice that is tailored to their client’s specific financial circumstances and goals. Investors can take advantage of the portfolio manager’s expertise while ensuring that their personal needs and preferences are accounted for.

A non-discretionary management approach also provides investors with the chance for educational opportunities. Working closely with their portfolio manager, investors can gain fresh insights into market analysis, investment strategies and the decision-making process. This can expand their current investment knowledge and help them to make more informed decisions in the future.

The disadvantage of discretionary management for clients is the time and effort that active involvement requires. Investors must dedicate time and effort in reviewing investment recommendations, performing research and making their own decisions. This process can be challenging for people with limited time and is not suited to those who seek a hands-off approach to managing their investments.

It understood that many clients who select a non-discretionary management approach might not share the same level of expertise as a portfolio manager. Although they receive expert recommendations and advice, they might need to acquire the experience and specialised knowledge that a manager has, or there is a chance that investment decisions made might not always be optimal.

Negative emotional bias can also be an issue. Non-discretionary portfolio management requires clients to make decisions that can sometimes be influenced by negative emotions like fear or overconfidence. This can lead to poor investment choices, like selling or buying based on short-term changes in the market fluctuations instead of focusing on long-term investment objectives.

Are you looking for experts in portfolio management in Shropshire and Chester?

At Hartey Wealth Management, our portfolio management service offers portfolios invested in both passive and actively managed collective funds.

We provide investors with access to a wide range of asset classes to ensure diversity and effectively manage risk. Reach out to us today to discuss your investment needs and objectives.

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