An Active Portfolio Strategy is an investment strategy that tries to maximize a portfolio’s value.
Investors and fund managers use various techniques that evaluate which financial securities will yield the greatest returns – yield refers to what percentage of return an investment generates.
In an active portfolio strategy, market analysis plays a critical role, with managers constantly evaluating global economic indicators, political events, and company-specific news to inform their investment decisions.
There are two main types of portfolio strategies: passive and active strategies.
A passive strategy has a more hands-off approach, while an active strategy involves the ongoing trading of investments.
An active portfolio strategy tries to generate maximum value by using as much information that is available and forecasting techniques to outperform a buy-and-hold portfolio. It has a long-term aim of moving capital consistently into profitable securities.
Active portfolio strategy
Portfolio managers say that an active portfolio strategy probably performs better than a buy-and-hold portfolio. With an active portfolio, investors try to move capital away from poor-performing stocks. Above all, the aim is to transfer the money into potentially higher-performing securities.
For example, active portfolio managers, whose benchmark is the Standard and Poor’s 500 index, will attempt to generate returns that outperform the index.
They will do this by over-weighting certain industries or securities – essentially allocating more to specific sectors than the index does. They believe that these targeted sectors are outperforming others.
Portfolio managers could choose not to employ an active strategy based strictly on future interest-rate movements. They could make an interest-rate bet to account for inferior performance relative to a benchmark.
Essentially, this portfolio strategy is more dynamic than others, because investment decisions change much more frequently. It attempts to make the most of market inefficiencies. However, active portfolio strategies are more costly.
Modern active portfolio strategies increasingly leverage advanced algorithms and machine learning techniques to analyze vast datasets and identify investment opportunities more rapidly than traditional methods.
Through active management, the degree of liquidity for the securities can increase portfolio costs. In contrast, passive management uses infrequent trading trends that minimize portfolio costs.
Stock selection
There are two main types of active management approaches to choosing stocks:
Top-down – this approach involves analyzing the market and then predicting which industries will perform the best. The focus is on the current economic cycle. Managers then pick stocks in these industries that are likely to do well.
Bottom-up – this approach does not take into account market conditions and trends. Managers choose stocks according to the strength of a company’s financial performance. Additionally, they analyze what senior management is planning for the future.
The bottom-up approach assumes that firms performing well will continue doing so even in volatile markets.
Risk
There is one major drawback with active management approaches. It is very uncommon for active portfolio managers to beat the market. Consequently, many investors prefer a simple indexing strategy.
Most investors prefer a strategy which allows a portfolio to grow from the long-term growth of the economy.