An introduction to active investing and some viewpoints with regards to this controversial topic.
We previously shared some reasons on why passive investing should be considered for those who are too busy or not savvy enough to constantly be checking on the stock market. However we do know that there are quite a few people who would prefer a more active position for investing.
Whether you are someone who is looking to actively invest, or just like to find more about active investing, it is important to first understand what Active Investing actually is.
What is active investing?
Active investing is a form of investment strategy that involve ongoing buying and selling of assets in the hopes of outperforming the benchmark index.
‘Benchmark Index’ – a gauge of the performance with regards to a certain stock market. In the index, it consists of stocks depending on the criteria set by the country’s stock exchange. Investors and fund managers will typically use it to compare the performance of their portfolio.
Being involved in active investing does not only refer to individuals who are frequently monitoring the stock markets and looking to trade actively. People who put their money into a unit trust or actively managed fund are also considered to be active investors, only differences being that someone else is being appointed to do the investing on their behalf.
Who is active investing for?
Active investing is for individual who are seeking a return above and beyond the average return for a particular market or sector.
Active investing requires the investor to constantly be keeping track on events and circumstances that shape the market’s direction. The investor focuses on sectors and companies that they are vested in, and a significant amount of work is required for analysis. This is in contrast to passive investing whereby an investor may just buy the benchmark index.
In Singapore, some form of active investing is usually present in instruments such as unit trusts. Unit trusts are investment vehicles that pool together contributed funds from an investor base. These funds are managed by fund managers who actively search for ‘good’ investment opportunities. Investment direction can be in the form of a theme such ‘region-specific’, ‘country specific’ or ‘sector specific’. As retail investor, it is our responsibility to make sure that these investments are aligned to our investment time horizon, risk profile and that we are aware of management fee incurred.
Why Active Investing may work?
Theory of Asset Allocation
Asset Allocation is a strategy whereby a mixture of different asset classes, with returns that are uncorrelated, are used in a portfolio to help optimise returns given a certain degree of risk.
The importance of a well-diversified portfolio should not be understated. For example, we know that shares and treasury bonds are inversely related. When economic situation worsens, people tend to go for safer and secured bond instruments. The returns are uncorrelated between the falling stock prices will be offset (supposedly) by the uptick in bond prices .
An experience fund manager would be able to structure a portfolio that is best suited to the needs of an individual. This is especially true if the individual does not have sufficient knowledge to do it on his own.
Protection in down markets
Active managers are in the best position to react to economic changes. They are able to liquidate their position quickly and hedge losses more effectively. In addition, active managers are able to identify opportunities and invest ahead of the markets. Contrast that to index funds, which cannot take precautions to preserve the value of the funds. When stock indices fall, the index funds that track the indices fall with it.
Knowledge and technical expertise of fund managers
Fund houses usually have research teams that are able to identify opportunistic areas to invest before the rest of the market catches on. This enables them to enter good opportunities eariler than the average retail investor. Complement that by the fact that investment companies also have the ability to use complex instruments to hedge and invest in markets that are not available to retail investors.
Fund managers are also able to eliminate sluggish investments in favor of more profitable ones. In comparison, even though a security in an index is not performing, the fund manager of the index fund cannot buy and sell the stock as and when he deems fit. There is a lack of flexibility in index funds.
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Royalty-free photo from Getty Images. Used with appreciation.
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