An actively managed fund is a type of investment fund, such as a mutual fund or exchange-traded fund (ETF), where a dedicated fund manager or team makes specific investment decisions to outperform a given benchmark index. This approach falls under the broader category of investment management and contrasts with passive strategies that merely track an index. The goal of an actively managed fund is to generate superior return through strategic stock picking, market timing, or other techniques, aiming to achieve alpha, or returns in excess of the benchmark.
History and Origin
The concept of actively managed funds predates modern financial markets as we know them. Early forms of pooled investments, managed with a discretionary approach, existed in various forms long before the advent of regulated investment vehicles. The formalization of actively managed funds, particularly mutual funds, gained significant traction in the United States in the early 20th century. The Investment Company Act of 1940 was a pivotal piece of legislation that established the regulatory framework for investment companies, including mutual funds, and is often credited with fostering their growth and public trust.15,14 This act addressed concerns about investor protection and provided a structured environment for investment pools where professional managers would actively select securities with the aim of maximizing shareholder value.
Key Takeaways
- An actively managed fund seeks to outperform a specific benchmark index through the discretionary decisions of a fund manager.
- The primary goal of active management is to generate "alpha," or returns exceeding the benchmark, after accounting for risk.
- These funds typically involve higher management fees and expense ratio compared to their passively managed counterparts due to the costs associated with research, trading, and professional oversight.
- Success in active management relies heavily on the skill and insights of the fund manager, as consistent outperformance is challenging to achieve in efficient markets.
- Actively managed funds are a cornerstone of traditional portfolio management and offer investors access to professional expertise.
Interpreting the Actively Managed Fund
When evaluating an actively managed fund, investors typically assess its performance relative to its stated benchmark over various time horizons. A key metric is the fund's ability to consistently generate positive alpha, meaning it has outstripped the benchmark after accounting for fees and expenses. It is crucial to consider the fund's investment strategy and how well the manager adheres to it. For instance, a small-cap growth fund should be evaluated against a small-cap growth index, not a broad market index. Analyzing factors like turnover (how frequently assets within the fund are bought and sold) can also provide insights into the manager's approach and potential trading costs. Funds with high turnover may incur higher transaction costs, which can eat into returns. The fund's diversification strategy is also important to consider, as well as its historical volatility compared to its benchmark.
Hypothetical Example
Consider "Growth Masters Fund," an actively managed fund with a stated objective to outperform the S&P 500 Index. The fund manager, Sarah, believes certain technology and healthcare stocks are undervalued.
- Scenario: At the start of the year, Growth Masters Fund has $100 million in assets under management (AUM) and the S&P 500 is at 4,000 points.
- Sarah's Actions: Throughout the year, Sarah conducts extensive research, meets with company executives, and uses her insights to buy and sell stocks. For example, she identifies a promising biotech company not yet in the S&P 500 and invests a significant portion of the fund's capital. She also decides to underweight certain large-cap technology stocks that she believes are overvalued.
- Year-end Performance:
- S&P 500 Index: Increased by 10% to 4,400 points.
- Growth Masters Fund: After all trading costs and management fees, the fund's net asset value per share increased by 12%.
- Result: In this hypothetical example, Growth Masters Fund achieved an alpha of 2% (12% fund return - 10% benchmark return), successfully meeting its objective of outperforming the financial markets benchmark.
Practical Applications
Actively managed funds are widely used by investors seeking expertise and the potential for enhanced returns beyond market averages. They are a core component of many retirement portfolios and institutional investment strategies.
- Strategic Allocation: Investors might use actively managed funds to target specific market segments, industries, or asset classes where they believe active management can add value, such as emerging markets or small-cap stocks.
- Niche Markets: In less efficient markets, where information might not be fully priced into securities, an actively managed fund has a greater opportunity to identify mispriced assets. This could include specialized sectors, micro-cap companies, or certain fixed-income segments.
- Downside Protection: Some active managers aim to reduce volatility or provide downside protection during market downturns by tactically shifting allocations or holding more cash. While not guaranteed, the flexibility of an actively managed fund allows for such defensive maneuvers.
- Behavioral Arbitrage: Skilled active managers may seek to capitalize on market inefficiencies driven by investor behavior, such as overreactions to news or irrational exuberance.
- Customization and Specialization: Active funds can offer specialized exposures that are difficult to achieve with broad index funds, catering to specific investor preferences or thematic investment ideas.
- Regulatory Framework: The operation of actively managed funds, especially mutual funds, is subject to regulations designed to protect investors and ensure transparency. For instance, the SEC provides detailed guidance on the regulation of investment companies, which covers many actively managed vehicles.13 A study by Research Affiliates highlights how active management can potentially navigate and even thrive in crisis periods by exploiting market dislocations.12,11,10
Limitations and Criticisms
Despite their potential advantages, actively managed funds face several limitations and criticisms:
- Underperformance: A significant body of research, including the S&P Indices Versus Active (SPIVA) Scorecard, consistently shows that a majority of actively managed funds underperform their benchmarks over long periods after accounting for fees.9,8,7,6, This underperformance is often attributed to the difficulty of consistently beating market efficiency and the drag of higher costs.5
- Higher Costs: Actively managed funds typically charge higher management fees and have higher operating expenses compared to passively managed alternatives. These costs, including trading commissions, research expenses, and portfolio manager salaries, can significantly erode any potential outperformance (alpha) that the manager might generate.4,3,2
- Inconsistency: Even funds that outperform in one period often struggle to maintain that outperformance in subsequent periods, a phenomenon known as "persistence" in active management research.1
- Style Drift: Some active managers may deviate from their stated investment style or mandate in an attempt to improve performance, which can alter the fund's risk profile and lead to unintended portfolio exposures for investors.
Actively Managed Fund vs. Passively Managed Fund
The fundamental difference between an actively managed fund and a passively managed fund lies in their investment approach and objective.
| Feature | Actively Managed Fund | Passively Managed Fund |
|---|---|---|
| Objective | To outperform a specific benchmark index. | To replicate the performance of a specific market index. |
| Strategy | Employs a fund manager or team to select securities, time markets, and make discretionary decisions. | Automatically invests in all securities of a chosen index according to their weightings. |
| Costs | Generally higher management fees, trading costs, and expense ratio. | Generally lower fees and operating expenses due to minimal human intervention and trading. |
| Trading Activity | Higher turnover, as managers frequently buy and sell securities. | Lower turnover, primarily rebalancing to match the index. |
| Performance Aim | Seeks to generate alpha (returns above the benchmark). | Aims to achieve return equal to the benchmark index (beta). |
While actively managed funds strive to beat the market, passively managed funds aim to simply track it, offering market returns at a lower cost and often with lower risk relative to an actively managed fund attempting to deviate significantly from the market.
FAQs
What is the primary goal of an actively managed fund?
The primary goal of an actively managed fund is to generate returns that exceed those of a specific market benchmark index over time. This outperformance, known as alpha, is achieved through the expertise and strategic decisions of a fund manager.
Are actively managed funds more expensive than passive funds?
Yes, actively managed funds generally have higher management fees and higher expense ratio compared to passively managed funds. This is because active management involves costs associated with research, analysis, frequent trading, and the compensation of the professional investment team.
Can an actively managed fund lose money?
Yes, like all investments, an actively managed fund can lose money. While the goal is to outperform, there is no guarantee of positive returns. The value of the fund's holdings can decrease due to market fluctuations, poor investment decisions by the manager, or unforeseen economic conditions. The risk of loss is inherent in investing in financial markets.