Active Vs Passive Portfolio Management : What are the differences and advantages

Portfolios of investments can be managed in two ways, depending on how actively they are managed. We have covered the following in this article:

What is Active Management?

Active management of investments includes relentless selling and buying of securities. The main intention of extensive activity of buying and selling of assets or securities is to outdo the markets collectively. Active management of investments is targeted at making the most out of the market situation, especially when the markets are on the upward movement.

Active management of mutual funds involves fund managers juggling across various debt or equity instruments in pursuit of making good profits. However, this is beneficial when the markets are fluctuating. This needs an immense understanding of the markets and its advisable that new investors with minimal to no market knowledge stay away from actively managing their investments.

Fund managers are used to actively managing investments, and they have a team of experts whose work is to forecast and suggest the possible actions that may benefit the investors. The team of experts and fund managers will forecast and take decisions accordingly.

What is Passive Management?

Passive management of investments is a method in which the fund managers or the investors implement a laidback approach. This involves tracking a benchmark index to replicate its performance. The primary intention of the passive way of managing investments is to generate returns similar to a benchmark index.

This can be done by investing in the same securities that the benchmark index is made up of. The idea here is not to outdo the benchmark but to generate returns that are in line with it. Unlike investments that are actively managed, the passively managed investments don’t need a team of experts who regularly track market performance. This is because the securities and assets don’t change frequently.

The most popular examples of passively managed investments are index mutual funds and exchange-traded funds (ETFs). Here, the fund manager does nothing more than replicating the performance of the benchmark indices being tracked.

Advantages and Disadvantages of Active Management

The most significant benefit of actively managing a portfolio is that it offers an opportunity for fund managers to generate much higher returns than the benchmark and thereby keeping the alpha on a higher side. Also, actively managing investments helps fund managers to make full utilisation of the risk profile of the investors.

Actively managed portfolio of investments comes with a higher cost as it includes a relentless activity of selling and buying of securities and thereby incurring a transactional cost every time a trade is placed. Also, there is no guarantee that the call made by the fund manager turns out to be beneficial for the investors.

Advantages and Disadvantages of Passive Management

As passive management of investments does not involve continuous selling and buying of securities; therefore, the cost involved is lesser. Also, it is easy to track the performance as knowing how well the underlying index has performed will give the required insights.

A significant disadvantage of passively managing investments is that the returns are always restricted. The returns offered will never exceed that of the underlying index that is being tracked.

Active Vs Passive Portfolio Management

Parameter	Active Portfolio Management	Passive Portfolio Management
Overall cost	High	Low
Returns	High	Low
Risk	High	Low
Suitability	For those willing to take some risk	For those who are risk-averse

Conclusion

Both actively and passively managed funds have their own advantages and disadvantages. The investors must assess their requirements and risk profile before making a decision.