Financial Education

There are three basic categories of equity portfolios: passive, active and semiactive.

A passively managed portfolio seeks to match the returns of a specified benchmark as closely as possible. For example, an S&P 500 index fund attempts to mimic the return on that index. The actual implementation of the strategy requires actively buying and selling stocks as the index constituents change, pay dividends and issue or repurchase shares. However, the manager does not try to earn returns above those of the index itself.

An actively managed portfolio seeks to earn returns better than those of the specified benchmark by applying skill, typically in the form of either security selection (choosing stocks that will earn higher returns) or market timing (investing more aggressively at times the market is expected to perform better). The risk to active management is two-fold. First, since the average opinion of active managers is by definition the market index, the average manager cannot beat the index. Second, since active management generally involves more trading it results in higher transaction costs. Therefore, the average active manager is expected to earn the index return, less the additional transaction costs. A superior manager must earn sufficiently higher returns to justify the higher transaction costs.

A semiactive approach seeks to mitigate the risks associated with active management by controlling certain factors such as industry weighting or market cap. For example, an industry-neutral fund may require the weight of each industry to be equal to that industry’s weight in the benchmark while allowing the manager to choose those stocks within the industry expected to offer the highest return.

For more information, see all articles on: Investing in Stocks, Portfolio Management, Security Selection

See also:

Dynamic and Static Approaches to Asset Allocation

Questionnaire for Equity Investment Managers

Approaches to Security Selection

Residual Income

Passive Investment Vehicles