To understand active stock portfolio management, it helps to compare this investment method with another style known as passive investing. In an active portfolio, a fund manager buys and sells financial securities in response to changing market conditions. A passive investment portfolio is created to perform as well as a particular industry benchmark, and the portfolio securities do not change as frequently. The fees associated with active portfolios are higher because a manager is expected to provide returns that are better than average.
Active portfolio management occurs in certain mutual funds and most hedge funds. Mutual funds are investment portfolios run by professional money managers that combine the assets of multiple investors and trade according to a given theme for a fee. These managers generally use long-only strategies, which are bets that financial securities will rise in value. Hedge fund managers also use an active approach but are more prone to deviating from long strategies in an attempt to provide above-normal returns.
Active-portfolio managers are expected to know how to produce returns that exceed the performance of passively managed index funds. Because these managers are using their abilities and techniques to outperform the markets, they are typically paid higher fees than what passive managers earn. For an active manager to be deemed successful, investors must earn profits that exceed market returns once fees and taxes are paid, according to consulting firm Towers Watson.
Exchange traded funds are investment portfolios that are filled with many financial securities but trade like stocks in the financial markets. Most ETFs are passively managed, but certain portfolio managers have started actively managing these funds, according to a 2012 article by "The Wall Street Journal." The fees for actively managed mutual funds and ETFs are similar. However, the latter offer investors the option to buy and sell more frequently because, unlike some mutual funds, ETFs are traded in the stock market.
Although actively managed portfolios charge fees that are higher than passive funds, investment performance often favors passive funds, according to the Wharton School of Business at the University of Pennsylvania. For more than two decades leading up to 2009, actively managed stock mutual funds that are meant to outperform some industry benchmark fell short of that barometer by 1 percentage point on average. Passive fund performance more closely mirrored benchmarks and therefore these portfolios delivered more attractive returns than active funds in this period.
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