Question

"An individual with a passive approach invests in securities for the long term, while the person with an active approach seeks to take advantage of market inefficiencies."

Which investment strategy do you prefer - active or passive? Compare the two strategies and explain why you prefer one over other

Answer 1

Active Vs. Passive Management:

Active Manager-Security Selection:

The Manager believes that the markets are inefficient and the stocks are mispriced. Accordingly, he will go long(Buy) on underpriced stock and short(Sell) on overpriced stocks.

Active Manager-Market Timings:

This manager believes that he has the skill to time the market i.e. he would increase the Beta of the portfolio when the market is expected to rise and decrease the Beta of the portfolio when the market is expected to fall. This can be done by shifting fund between high and low beta stocks or by borrowing or lending at Rf.

Passive Manager-Indexing:

A passive manager believes that the markets are efficient i.e. all the stocks are correctly priced. So, he does not engage in security seletion. Also he believes that it is impossible to time the market. So he does not engage in market timing. He simply tries to replicate a benchmark Index like the sensex or nifty.

Conclusion: All this evidence that passive beats active investing may be oversimplifying something much more complex, however, because active and passive strategies are just two sides of the same coin. Both exist for a reason and many pros blend these strategies.

However, recent reports suggest that in the current market upheaval, actively managed Exchange-Traded Funds (ETFs) are soaring. While passive funds still dominate overall, due to lower fees, investors are showing that they're willing to put up with the higher fees in exchange for the expertise of an active manager to help guide them amid all the volatility.