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| Active Management |
What It Is:
Active management is an investment strategy that seeks to create returns in
excess of a specified benchmark (usually some broad market measure) through the
recognition, anticipation, and exploitation of short-term investment trends.
How It Works/Example:
Active management is the opposite of passive management (also known as
buy-and-hold investing). Instead of dismissing short-term trends and focusing on
long-term profits, active managers believe short-term price movements are
important and often predictable. In this vein, active managers often refer to
statistical anomalies, recurring patterns, and other data that supports a
correlation between certain information and stock prices.
For any given investment, the passive manager is likely to rely more on the
fundamental analysis of the company behind the security, such as the company�s
long-term strategy, the quality of its products, or the company�s
relationships with management when deciding whether to buy or sell. This type of
analysis is largely intended to evaluate the investment�s long-term potential,
which is the passive investor�s typical investment horizon.
The active manager, however, seeks to detect and exploit short-term trends in a
security. This often involves quantitative and technical analyses, including
ratio analysis, stock chart analysis, and other mathematical measures that have
less to do with the nature of the company and more to do with trading patterns,
news, and other market factors. An active manager�s investment horizon can be
months, days, or even hours or minutes.
Why It Matters:
In general, the constant analysis associated with active management involves more trading activity than passive management. Active trading thus also generally requires more time and education than passive management, and it is important to note that the higher trading commissions and capital gains taxes may translate to higher management fees and return requirements.
The idea of active management is not immune from controversy. Passive managers note that active managers frequently fail to match or beat their benchmarks, and they question the reliability of active managers� methods for recognizing and predicting trends. But the most notable areas of disagreement between active and passive managers are theoretical rather than mechanical.
Many
passive managers espouse the efficient market hypothesis, which says that stock
prices are random and already reflect all available information. A cousin of
this hypothesis, the random walk theory, also claims it is impossible to
consistently outperform the market, particularly in the short term, because it
is impossible to predict stock prices.
Regardless, active management enjoys a large and loyal following among
investors, and many active managers have posted returns well above market
benchmarks. However, consistently providing above-average returns remains a big
challenge.
No matter where they rest on the issue, most analysts encourage even the most
passive investor to learn about and understand active management methods, stay
current on their investments, and know how to read stock charts.
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