What is Active Portfolio Management?
- 7 min read
With the Indian financial markets becoming more dynamic and accessible, investors are increasingly looking for ways to make informed and timely investment decisions. As market volatility and economic shifts continue to influence returns, many are turning to more hands-on approaches to stay ahead.
In this evolving landscape, understanding how to manage investments actively has gained significance. This blog takes a closer look at active portfolio management, its strategies, and the benefits and challenges it presents in the Indian context.
What is Active Portfolio Management?
Active portfolio management is an investment approach in which investors and fund managers make active investment decisions based on the current market conditions. This ensures the returns from the portfolio can outperform a market index such as the BSE Sensex or Nifty 50.
Fund managers using this strategy regularly adjust portfolios to maximise profits by analysing economic data and market shifts. Analysis of individual companies when making purchase or sell decisions also helps them in adjusting portfolios.
Active portfolio fund managers go beyond simply replicating an index; they analyse market inefficiencies to generate returns. They identify undervalued stocks and apply various active investing strategies to capitalise on opportunities.
However, despite these efforts, most active managers struggle to consistently outperform passively managed funds. Additionally, the cost of managing active funds tends to be higher compared to passive alternatives.
Active Portfolio Management Example
To better understand active portfolio management, let us consider a practical example. Imagine a mutual fund that invests in a diversified mix of equity securities across different sectors, such as technology and banking. The Nifty 50 index serves as the benchmark against which the fund’s performance is measured.
After conducting thorough market research, the fund manager identifies that technology stocks are currently undervalued and poised for growth due to increasing demand for digital solutions. At the same time, the analysis suggests that the banking sector may underperform because of rising credit demand and sluggish deposit growth.
Acting on this insight, the manager increases exposure to high-performing IT companies while reducing holdings in banking stocks to avoid potential losses.
If the market responds as anticipated, the mutual fund’s returns may outperform the Nifty 50. This example illustrates how active portfolio management involves strategic adjustments based on market trends and economic forecasts to enhance performance.
Different Strategies of Active Portfolio Management
Now that you have understood what is active investment management, it is essential to have a look at the various strategies involved in it. Below are some of the different strategies used in active portfolio management:
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Asset Allocation
Asset allocation is the strategy of investing your capital in different asset classes. According to your financial goals and risk tolerance, you can make a combination of your asset selection.
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Sectoral Rotation
The sectoral rotation strategy means changing investments between sectors depending on market trends. For instance, a fund manager may change the portfolio’s allocation towards retail companies to increase returns if they believe that these stocks will perform better in the future.
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Market Timing
Market timing strategy entails the purchase and sale of stocks according to the predictions of future market movements. Although it is challenging, effective timing in the market can enhance returns.
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Fundamental Analysis
Fundamental analysis is the technique to find the intrinsic value of an asset. It helps to determine whether the value of a security is overvalued or undervalued.
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Technical Analysis
Technical analysis is the strategy of predicting the future price movements of an asset according to its historical price data.
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Risk Management
The risk management strategy takes measures to protect the value of assets from declining in poor market conditions. Diversification, setting stop-loss orders, and hedging are some of the risk management techniques that a portfolio management strategy consists of.
Best Methods for Managing an Active Portfolio
Portfolio managers need to implement effective methods to become successful in active portfolio management. Here are some of the best methods to actively manage a portfolio:
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Set Clear Investment Goals
Investors need to create specific investing goals that are in line with their risk tolerance and financial objectives. This can help investors in maintaining focus and avoiding rash financial decisions.
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Conduct Regular Reviews
Try to review and rebalance your portfolio regularly to make sure it aligns with your risk profile and investment objective.
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Adjusting Investment Strategies
You should monitor market conditions and make changes in your plans as necessary. This might include changing asset allocations or taking other financial decisions.
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Maintain a Disciplined Approach
Staying disciplined and maintaining consistency is fundamental for long-term success in the active management of a portfolio. You need to stick to your plan irrespective of the market conditions and avoid making emotionally driven decisions.
Benefits of Active Portfolio Management
Active portfolio management offers numerous benefits to investors, like higher returns and flexibility, which are described in the pointers below:
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Higher Returns
Investors can benefit from higher returns due to the ability of this strategy to outperform market benchmarks and indexes.
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Flexibility
This strategy enables investors to tailor their investment portfolios to their individual risk tolerance and investment objectives. This can reduce risk while assisting investors in reaching their financial goals.
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Diversification
To reduce the risk of investment losses and boost returns, investors should diversify their portfolios among a variety of asset classes.
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Tax Considerations
Active portfolio management comes with tax-efficient investment strategies like tax-loss harvesting. This strategy offsets losses with gains to minimise the tax on returns.
Limitations of Active Portfolio Management
While offering numerous benefits, active portfolio management also comes with a lot of drawbacks. These are the limitations of this strategy that you should be aware of:
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Risk of Underperformance
Compared to passive methods, active portfolio management has a higher risk of underperformance since active managers are more prone to make poor investment choices.
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No Success Guarantee
Even though the ultimate goal of this strategy is to outperform the market, not all fund managers are successful as some active funds could do worse than their benchmark.
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Higher Costs
Active management of a portfolio is costlier than passive management since investors have to pay transaction costs which can result in lower returns.
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Difficulties in Maintaining Consistency
Even the most experienced portfolio managers may find it difficult to accurately predict market changes due to the complexity and dynamic nature of markets.
Final Thoughts
Active portfolio management entails carefully choosing securities and distributing assets depending on market trends. To outperform the market, managers employ a variety of strategies like asset allocation, risk management, market timing, and technical analysis.
The benefits of this strategy are flexibility, higher returns, diversification, and tax considerations.
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Frequently Asked Questions
1. What are the main goals of active portfolio management?
The main goal of active portfolio management is to maximise profits by evaluating market inefficiencies. In addition, it aims to generate profit by outperforming the benchmark index.
2. What kinds of assets are usually included in an actively managed portfolio?
Stocks, debt securities, commodities, and cash are some of the asset types that are included in an actively managed portfolio.
3. Are all kinds of investors able to benefit from active portfolio management?
Active portfolio management can benefit investors who want quick adjustments to shifting market conditions with freedom.
4. Can active portfolio management guarantee higher returns than passive management?
Yes, investors can benefit from higher returns due to active portfolio management’s ability to outperform market benchmarks.
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Disclaimer: This blog has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. It is based on several secondary sources on the internet and is subject to changes. Please consult an expert before making related decisions.
