Outperform the Market: An Overview of Active Asset Management

Benefits of Active Asset Management

Active asset management has been popular among investors for many reasons. The strategy has several attractive upsides.

Adaptability in Changing Market Conditions

Active managers can quickly react to unforeseen changes in the market or world events, adapting their investment strategies to make the most of the current situation. Active managers’ ability to pivot and adapt can offer protection from market exposure risks and allow them to prioritize unique and time-bound opportunities passive investors would miss. For example, if a certain investment sector is crashing or expected to crash, active managers can adjust that sector’s prevalence in the portfolio to limit an investor’s risk in that sector. They can also take advantage of market volatility to buy low and sell high for short-term gains that can provide a quick burst of income and add up over time.

The Possibility of Higher-than-Average Returns

Passively investing in an index to match average returns can seem like a lackluster strategy to those who value hard work and success. Because active managers aim to outperform the market, they will adjust their strategies to increase profitability whenever possible. Active asset managers do their best to anticipate changes in the market, buying stock in companies they think are undervalued and avoiding short-selling those they deem overvalued or likely to drop in value in the near future. Their extensive research and market analysis can provide insights the average busy investor might not have access to on their own. When done well, active management allows for short- and long-term success far beyond the average returns passive strategies can offer.

Diversification

Working with an active asset manager can give investors access to assets and investments they would otherwise be barred from, such as hedge funds. Active managers can also research and select promising stocks in more niche market categories, such as emerging markets, that are not correlated to the US stock market. These types of assets can further diversify your portfolio, limiting risk and increasing opportunities for success. 

Drawbacks of Active Asset Management

Despite the benefits, many investors cite active asset management’s potential risks and expenses as reasons to employ a more passive investing strategy. Below are some of the most common gripes people have with active management.

Higher Fees 

A professional’s time and experience are not free, so actively managed funds tend to come with higher fees than passive funds. These fees pay for the time, energy, and resources active managers devote to researching market trends and adapting your investments to position you for a better chance at success. These fees can cut into your overall returns, meaning that an actively managed fund has to outperform its benchmark by a greater margin for individual investors to actually benefit from its profits. 

Higher Taxes

Actively managed mutual funds tend to have a higher turnover rate than passive funds, meaning that stocks within the fund are bought and sold more often. This higher turnover can make some actively managed funds less tax-efficient than other investing options because each sale is a taxable event (i.e., if you sell a stock at a profit, you pay capital gains taxes on that profit). Some active managers attempt to offset these capital gains taxes with a strategy called tax-loss harvesting, which involves selling an investment for lower than you bought it and immediately purchasing a comparable investment to maintain the balance of your portfolio while claiming a loss to counterbalance gains you have generated with other investments. 

Risk of Human Error 

The stock market can be unpredictable, and nobody can accurately predict the future 100% of the time, so there is the risk that active managers may occasionally slip up or make a bad call that causes you to lose money or miss an opportunity. However, professional active asset managers have much more experience and can access better resources than the typical individual stock picker. The best active asset managers mitigate the risk of human error with their years of experience and the time they devote to researching and refining their skills. Not all active managers will achieve their lofty goals or meet your individual investing needs and preferences, so when selecting an investment manager, it is vital to familiarize yourself with their experience, overall track record, and investing philosophy as well as the fees or commissions they charge.