Actively managed

Definition: A description for mutual funds that are managed by financial professionals who use their education, knowledge, and experience to choose investments they believe will do better than the stock market overall.

Example: The Prestige Fund manages $2 billion of investors’ money. A team of 20 financial professionals works full-time to identify companies that are attractive to invest in. They meet regularly to discuss the state of the economy and the markets, and to decide which, if any, stocks to buy and sell. The Fund invests in large companies that are similar in size to the unchanging list of 500 big companies that make up the S&P 500 Index. They believe that their smart decisions will cause the value of the Fund to grow more the value of the stocks in the S&P 500 Index.

The expertise of financial professionals does not come free! Actively managed mutual funds charge investors higher annual fees than those of passively managed funds which simply copy a popular index such as the S&P 500. For example, an actively managed fund such as Prestige may annually charge 1% of the amount of money it manages, while a passively managed fund may charge its shareholders just .3 % per year.

Investeach explains: Continuing with the above, let’s say that the investments in the Prestige Fund went up in value 10% this year while the S&P 500 went up 9.5%. Prestige appears to have done better, but let’s take a look at the results after operating fees are subtracted. The rate of return actually received by Prestige shareholders is 10% – 1%, or 9%. The return of the fund that mimics the S&P 500 is 9.5% – .3%, or 9.2%. In this case, the half percent better return that the Prestige Fund achieved is not enough to make up for its higher fees, which are .7% greater than those of the passively managed fund.

Depending on the study you read, over the long term, 75% to 80% of actively managed mutual funds are beaten by the performance of the index they are designed to outperform! This is the reason why many financial planners and investment advisors recommend that investors put their money in passively managed funds (ie: those that mimic a unchanging list of popular companies) don’t employ highly paid financial professionals and which therefore charge low fees.

Riddle me this:

1. Why should actively managed funds achieve better performance than an unchanging group of companies such as the S&P 500 that represents the market overall?
2. What is the alternative to investing in an actively managed fund?
3. How do we compare the performance of a fund that is actively managed to one that is not?

Opposite of: Passively managed.