Question

1. Discuss active bond portfolio management. Given an inefficient market, is such portfolio management appropriate? Explain one active bond management strategy.

Answer 1

1. Active bond portfolio management do not replicate the benchmark, infact in this strategy managers buy more of those securities which are expected to provide higher returns and do not include securities which are not expected to generate higher returns. In active portfolio management we do not simply and buy and hold securities . Infact , we keep on rebalancing the portfolios by weighting or under weighting the securities on the basis of the individual stock returns or overall economic conditions.

Yes, in inefficient markets such a portfolio management is appropriate.

Active portfolio management uses the due diligence of the managers to select securities. In this strategy investors try to beat the market and not simply wish to earn the benchmark return. In an efficient markets, earning higher returns is not possible, even if use active management strategies but in inefficient markets it is possible to beat the markets and earn alpha(abnormal returns) by carefully selecting securities and over weighting securities which provide higher returns and under weighting securities pricing lower returns and not simply replicating the index weights.

One active management strategy is :

For example: Managers invest in sectors which are expected to perform better based on the economic conditions in the country. So, if the technology sectors is expected to outperform, higher investment will be made in the technology stocks, and the investments made in real estate and other sectors will either be reduced or completely withdrawn.