Active management is one in which the investor works to surpass the profitability of its benchmark index. The passive management fund, on the other hand, is more limited and does not give as much freedom for the investor to make “above average” decisions in relation to their investments..
The choice of an investment fund and the decision to invest the money in an assertive way necessarily passes through the understanding of the differences between active and passive management. Especially because this is an important step in determining which model fits your investor profile.
Active and passive management have their differences in points such as investment level risk and profitability. The great secret of investment funds is not to choose the option that will give you the most return, but the one that best suits you.
If, on the one hand, there are bold investors who seek to exceed the limits of the financial benchmark, which is the benchmark for investing, on the other hand, there are restrained people.
Within this scenario, the most important thing for designing an investment strategy is to answer: do I get more active or passive management of my money? To help you understand these two models, we have prepared exclusive content on the topic.
Are you interested? Just move on in this text and have a good reading!
Importance of benchmark financial
Before showing the differences and characteristics of active and passive management, it is important to understand what they mean in practice.
First, we need to know that the basis for differentiating active and passive management is in the so-called financial benchmark.
O financial benchmark is nothing more than a benchmark so that you have a base and get to know if your applications are doing well or not.
It works as a guide for the investor having several economic indicators to guide him between active and passive management. We can highlight among the main financial benchmarks in the market the following:
- Selic rate;
- Bovespa Index;
- Exchange rate;
- CDI rate;
- Inflation indicators;
- Exchange rate.
Based on these benchmarks the manager can make a macro and more concrete analysis of the success of his investments.
Especially because in a scenario where your investment gave a 20% return, for example, it is not possible to state exactly that this return was completely positive.
It all depends on the reference you have in the market, which in this case are called benchmarks. In the article “What is financial benchmark? Understand the concept and how to use it!” we explain the importance of this index.
What is active and passive management?
Now that we know how the fund management of investment funds works, we can go deeper into active and passive management. Let’s start by explaining the meaning of active management.
THE active management is one in which the investor works to surpass the profitability of his benchmark index. For that, he is always analyzing the market options and what alternatives can offer this type of possibility.
In the case of active management, the manager is more free to choose his assets, but in return he can have a very big challenge in being remunerated above the market average.
This task is not an easy one as a recent study of the Morningstar which indicated that in the past 20 years only 25% of American investment fund managers outperformed the index S & P500 – O benchmark reference in the USA.
Below we list the main features active management:
- Long-term efficient performance;
- Greater profitability;
- Freedom of investment;
- Non-static wallets;
- It demands a great market analysis.
While active management has a bolder investor profile for those who choose this model, passive management is quite the opposite.
At passive management, the pressure for high profitability results is less, as it is enough for the investor to achieve the same benchmark to be satisfied.
This means that he has, as the name implies, a passive role in the construction of his portfolio of financial assets. Therefore, the passive management fund is more limited and does not give the investor so much freedom to make decisions “above average”.
Check out the main features passive management.
- Replicate the performance of the benchmark;
- Ease to follow the market;
- Less pressure for results;
- Less volatility.
Active and passive management: advantages and disadvantages
The advantages of active management
Like any investment fund model, active management is not aware of offering advantages and disadvantages for those who adopt it.
Among the main advantages we can highlight the possibility of income above the benchmark and the creation of a non-static portfolio, giving more freedom to investor in this sense.
The disadvantages of active management
Regarding the disadvantages, we can point administration fees, which tend to be higher than passive management, and volatility due to the high investment risk.
In addition, as it is considered hard work, the value of hiring a qualified team in the area can be much higher than that of passive management.
The benefits of passive management
Within the passive management advantages scenario, we can highlight the administration cost, much less than active management, and predictability of results.
Another facility is the use of mathematical aspects in the investment process that allow an automation of management processes.
The disadvantages of passive management
The disadvantages of passive management are mainly related profitability. This is because, as it seeks, it is to match the benchmark. Therefore, it is not recommended for anyone looking for profits that are above the average of the benchmark index.
Not to mention that the investor has less freedom to risk, as he will always follow the standard index that ties him up and limits him to earn extra profitability. Its investment cartel, consequently, is smaller than that of active management investors.
What are the costs of investment funds?
Before opting for active or passive management in the market, it is also necessary to evaluate the investment fund costs.
We can highlight two of them as the main ones, which are part of its operating and administration cost. Are they:
- the administration fee;
- the performance fee.
The administration fee is related to the costs for maintaining the chosen fund. There is a variation in this rate that takes into account the complexity of managing it, for example, whether the investment is part of passive or active management.
Depending on the model, there is a greater requirement for analysis and strategy.
This also influences the performance fee, charged by some funds, which can be explained as a “prize” for those who manage to surpass the “benchmark”. It is important to note that this fee is charged daily from the fund’s quota.
What are the risks of investment funds
Investing in investment funds does not mean being away from the risks of financial market.
Therefore, it is important to recognize them and mainly to define strategies so that they are minimized and do not impact negatively and constantly on investments. Among the main risks of investment funds we can highlight:
- Liquidity risk: liquidity in the financial market is explained by the ease of transforming assets into cash. However, this does not always happen in investment funds and the work can be hard and risky in that sense. After all, there are no guarantees of results.
- Market risk: it is common for the market to fluctuate for several reasons, whether due to influences related to political, economic or international issues. Therefore, those who invest in investment funds are always susceptible to suffer from these market risks.
- Credit risk: there is also the possibility that those involved by the fund will not meet their obligations to pay interest. This is especially true for those who choose active management and want to be profitable that surpasses the benchmark.
Define your profile and assume the risks of the financial market
Investing in investment funds depends not only on a desire to be active in the financial market, but on a strategy on which model best suits your profile.
In this scenario, we have those investors who are more daring and more conservative.
They are divided between active and passive management as we have seen throughout this content. While one is constantly trying to beat benchmarks, another tries to match and replicate that benchmark.
How we know there is no financial market without riskstherefore, active and passive management have advantages and disadvantages. Each of these points needs to be evaluated and studied by investors in order for any action to be assertive.
Since mistakes in the financial market can make the investor lose a lot of money.
Before investing, it is essential to be clear about goals and objectives, not least because it is normal for the financial market to fluctuate and the investment fund is not a guarantee of credits. Which profile do you adapt to bold or conservative?
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