Asset management utilizes two main investment strategies that can be used to generate returns: active asset management and passive asset management. Active asset management focuses on outperforming a benchmark, such as the S&P 500 Index, while passive management aims to mimic the asset holdings of a particular benchmark index.
Explaining the Difference Between Passive and Active Asset Management
Investors and portfolio managers who implement an active asset management strategy aim to outperform benchmark indexes by buying and selling securities, such as stocks, options and futures. Active asset management involves analyzing market trends, economic and political data, and company specific news. After analyzing these types of data, active investors purchase or sell assets. Active managers aim to generate greater returns than fund managers who mirror the holdings of securities listed on an index. Generally, the management fees assessed on active portfolios and funds are high.
Contrary to active asset management, passive asset management involves purchasing assets that are held in a benchmark index. A passive asset management approach allocates a portfolio similar to a market index and applies a similar weighting as that index. Unlike active asset management, passive asset management aims to generate similar returns as the chosen index.
For example, the SPDR S&P 500 ETF Trust (SPY) is a passively managed fund for long-term investors that aims to mirror the performance of the S&P 500 Index. The manager of SPY passively manages the exchange-traded fund (ETF) by purchasing large-cap stocks held in the S&P 500 Index. Unlike actively managed funds, SPY has a low expense ratio due to its passive investment strategy and low turnover ratio.
The Advisor Insight
Many mutual funds use active management. For example, a mutual fund that invests in large U.S. companies would most likely use the S&P 500 Index as its benchmark. The objective of the fund would be to outperform the return of the S&P 500. The fund will do this by employing a manager and a team of analysts. The fund manager will pick stocks that he believes will outperform the S&P 500.
Normally, you pay more to invest in an actively-managed fund since you are paying for the fund manager’s expertise.
Passive management is usually done via ETFs or index mutual funds, which track a benchmark. The goal is to match the return of a benchmark, such as the S&P 500. Typically, it is much less expensive to employ passive management, as you aren't paying a manager for their expertise.
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