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What is the concept of active management in trading?

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What is the concept of active management in trading?

The term active management is used in situations where an investor, a financial manager or a group of professionals monitors an investment portfolio and makes decisions such as buying, selling or holding assets for it. Typically, a CFO’s success is based on recording better performance than an benchmark while achieving goals such as risk management, tax reduction, and compliance with ESG standards.

What is the concept of active management in trade and what is its application?

Active managers believe that if an investor is not satisfied with a performance similar to or slightly better than the market index, using active management is more suitable for him.

The active management process in trade consists of three main stages: planning, implementation and feedback.

  1. Planning stage: In this stage, the goals and limitations of the investor are defined and based on them, an investment policy statement is created. This statement includes reporting requirements, adjustment guidelines, communications of invested assets, management fee and trading strategy. Then, the active manager prepares his predictions about the amount of risk and the probability of profit of the assets and makes the asset allocation based on them.
  2. Implementation stage: In the implementation stage, after the creation and revision of the portfolio, it is implemented. Active managers implement their investment strategies to buy securities according to the expectations of the capital market and the information obtained. This action coordinates the portfolio optimization with the level of risk tolerance of the investor.
  3. Feedback stage: In the feedback stage, capital is managed through portfolio balancing using IPS information. The performance of the portfolio is also periodically evaluated by the investor to ensure the achievement of predetermined goals.

An example of active management

Investors who believe in active management do not support stronger forms of the efficient market hypothesis. On the contrary, supporters of this approach believe that investors who actively participate in the market and take advantage of the opportunities of frequent market fluctuations can achieve better performance than investors who passively follow the market indicators.

The difference between active management and passive management

In active management, managers react to capital market variables and adjust their strategies based on them, while in passive management, investors do not react to these variables and the fate of their investment portfolio is tied to a specific index.

In portfolio management, an investment policy statement should be created that outlines a fund’s strategy. In general, investment strategies can be divided into three main groups:

Passive investment strategy: does not react to capital market changes. For example, an investment portfolio tied to the S&P 500 index may add or remove a series of assets in response to changes in the index’s composition. But it does not react to the change in the value of a particular security in the market.

Active investment strategy: reacts to capital market changes. Active management of an investment portfolio means that the weighting of its assets is usually different from the weighting of the assets of the benchmark investment portfolio. The difference in the weight of the assets actually shows the different expectations of the active manager towards the whole market, and the purpose of this work is to record a better performance than the benchmark portfolio (Alpha).

Semi-active investment strategy: It is an improved approach to the index in which alpha is followed, but the risk of deviation from the benchmark is considered more.

The benefits of using active management include the ability to choose from a variety of assets and investment strategies. Some of the reasons that lead investors to active management are:

  • Investors’ belief that they can outperform the market or a specific index through active management (at least in the short term).
  • The possibility of choosing more skilled active managers.
  • Managing volatility differently from the market as a whole.
  • Following a specific strategy to match investment objectives.
  • Access to alternative assets that are not directly linked to the market, such as real estate.

Disadvantages of using active management include higher fees than passive management. This is due to the higher fees that the investor has to pay for the help of expert advisors in active investing as well as the proper performance of their portfolio relative to the market as a whole.

In addition, if active managers make poor investment choices, there is a possibility of losses, even if the active management process in the trade has a good result. In some cases, actively managed portfolios tend to underperform passively managed portfolios.

Is active trade management right for you?

Active management in trading means that a professional investment manager decides when, how much of which asset to buy or sell. In this management method, the goal is to perform better compared to a certain “benchmark”. This is in contrast to passive management, where a portfolio of assets is expected to perform the same or slightly better than an index. Therefore, if you are looking for a short-term investment strategy that has the potential for higher returns, active management can be a good choice for you. Of course, before investing in an active management fund or hiring a professional active manager, be sure to do thorough research and understand its potential risks.