What is active investing?
Active investing is an investment strategy that involves active buying and selling financial securities with the aim to generate higher than benchmark profits.
Active investing means a hands-on approach in the financial markets, where an active participant – typically a portfolio manager – analyses the markets in an attempt to ‘time’ it.
The active investing definition is based on the concept of timing the market, which means finding the most opportune time to buy and sell an asset to maximise portfolio returns. Active portfolios are based on the belief that they can beat an index or a passive portfolio by carefully analysing and selecting which securities should be traded and when.
Active investing example
Stock picking is one of the popular types of active investing. At the start of the Covid-19 pandemic, global lockdowns forced millions of people to work from home. During that time, an active fund manager could look into buying shares of companies that were expected to perform well in the new environment.
For example, Zoom Video Communications (ZM), a US tech company, helped teams have meetings online and saw its share price hit an all-time high during the pandemic.
Hedging could be another tool in an active fund manager’s arsenal. Under the hedging strategy, the manager continuously monitors the market for potential positions to reduce portfolio risk.
Active vs passive investing
Active and passive strategies are antithetical methods of investing. While the former involves constant buying and selling of securities to generate better returns, passive investing consists of buying and holding securities for longer without reacting to short-term price fluctuations. Investors hold through market volatility without trading for short-term gain or trying to time the market.
Pros and cons of active investing
Investing in active funds managed by dedicated portfolio managers can have both advantages and disadvantages.
Benefits of active investing
Gains based on expertise
Active investment strategy involves an in-depth understanding of the factors that shape the market direction. While a regular retail investor may not have that insight into markets, they can invest in a fund with a fund manager who has the skill set to actively manage their portfolio.
Based on the expertise of a fund manager, active funds can lead to generating higher returns than benchmark. The entire ecosystem of active investing is built on the concept that by timing the market active managers can gain higher returns than passively-managed or index funds.
Trading in financial markets can have significant tax implications. However, with active investing, a portfolio manager can navigate the markets and have the flexibility to execute tax-efficient trades which could be beneficial for the overall portfolio growth.
Disadvantages of active investing
Active investing typically involves hiring a fund manager who looks after your portfolio. These managers usually charge a high fee for their services, and your portfolio returns would ultimately have a cut for the manager’s compensation.
Active investing strategy may also involve a high volume of trading, which could also come at a higher fee.
Minimum investment threshold
Fund managers often can impose a minimum investment threshold for portfolio management. This limits active investing strategy to investors with higher amounts of funds.
Considering active investing strategy involves regular buying and selling of securities, there are higher transaction costs involved. These costs carry certain tax implications which hold the potential to bring down the overall portfolio returns in the form of higher capital gain tax charges.