There are two main types of investment strategy for anyone looking to generate a return: active portfolio management and passive portfolio management. In this guide, we assess the goals, costs and risks associated with each.
Active portfolio management
Active portfolio management has two core aims. The first is to generate returns greater than market indexes, while the second seeks to reduce the risk of investment losses. To achieve this, it deploys a number of different tactics and strategies to allocate assets. These are based on a range of market conditions and have the ultimate objective of outperforming the market.
Investors who pursue an active portfolio management strategy operate in liaison with a team of managers tasked with making decisions for an investment fund. A mutual fund is a good example of active portfolio management. Investment success invariably depends on the team’s research, insights, expertise and ability to forecast market trends. Portfolio managers’ typically hands-on decisions will also be influenced by factors unique to individual companies as well as monitoring external events, such as economic shocks or changes in the political weather. Such data is routinely used to inform and determine the timing of asset transactions, by adjusting asset allocations to factor in market conditions.
Portfolio managers will typically use a range of techniques that seek to maximise returns while minimising risk. These include careful attention to asset allocation to ensure a portfolio is divided between diverse asset classes, taking into account the investor’s risk tolerance threshold. When considering security selection, they will also use analytics to identify securities, which can outperform the market. Risk management techniques include derivatives or options to hedge against any market volatility.
In the UK, an annual fee is normally charged for active portfolio management services, which is usually somewhere between 0.5% and 2% of the AUM (assets under management). This covers research, expertise and trading costs provided by the fund manager. There may also be additional ‘entry and exit’ charges, depending on which investment vehicle is used.
When evaluating the pros and cons of active portfolio management, it is important to be mindful of the benefits and risks involved. The perks include flexibility and customisation, with opportunities for diversification, offering the potential to outperform the market across different sectors. Equally, however, you should be aware of the higher fees and costs, the risk of underperformance, currency fluctuations and global shocks.
To make a success of active portfolio management, you will require discipline, clear goals and an in-depth knowledge of market trends. Successful active portfolio management requires a consistent approach, as well as a deep understanding of market trends and conditions.
Passive portfolio management
Passive portfolio management (also referred to as index fund management) is designed to generate a return on investments on a selected index. As an investment strategy, it seeks to build long-term growth while, at the same time, minimising costs.
There are different types of passive portfolios, which can be created via a selection of methods. These are market-cap weighted portfolios, equal-weighted portfolios and factor-based portfolios.
Investors in any passive portfolio will eye a diversified selection of assets and monitor the performance of specific asset classes. This is a more hands-off approach that relies on algorithms and set rules, thus reducing human involvement and decisions. It appeals to ‘low-cost’ investors looking at the long game, or novices not yet equipped with knowledge to get actively involved.
There are various passive portfolio management approaches that may appeal, each with their own advantages and disadvantages. These include Index Investing, Asset Allocation and Buy-And-Hold Investing. Passive portfolio management does require careful consideration of factors such as asset selection, asset allocation, performance and rebalancing.
With less human involvement, passive portfolio management tends to incur lower costs. Passive funds, such as index funds or ETFs (exchange-traded funds), offer lower expense ratios and charge fees that annually range from as little as 0.1% to 0.3%. Other primary benefits for investors include a reduced portfolio turnover, and a significantly lower prospect of underperforming in the market. There are, however, potential downsides too, with more limited flexibility, greater exposure to downturns and possible tracking errors.
Ultimately, each investor will need to decide whether an ‘active’ or ‘passive’ approach is best. If you are based in the North West and seeking advice on asset management in Cheshire, contact specialist financial planner Hartey Wealth Management today to discuss a strategy that meets your goals.
