Money Management in the Organization

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Table of Contents

Introduction
Methodology
Implication and recommendation
References

Introduction

Money Management sometimes sounds like a science. The investment consultants or the fund mangers debate much on their trusted sources and the likely patterns. Usually investors do invest either by the knowledge acquired through friends or relatives or by consulting an investment expert. Invest mangers help in giving a balanced portfolio through out the economy. However the directions of the financial consultants not always results in gain. One such area of financial criticality is the investment option with Active vs Passive asset management. There is a much debate on the issue and several people an financial experts do analyze the historical perspectives of the Active vs Passive money management.

At times, both active and passive money management patterns can be used as inter –related techniques while doing the investment management by the managers. Some investment decision makers do not find much difference between the two investment management styles, so they adopt both in maintaining a portfolio. So the current paper tries to explain both the concepts from their definition and figures out their operational differences and their historical performance.

For any investment portfolio a good mixture of large, medium and small cap is required. However, for every kind of capital a due diligence is a must for the rate of return and to avoid risk. There is a connection between the approach adopted by an investor and profitability of the fund being managed. Still no Investment management style can be boasted as the only successful pattern in a long run. In the modern world businesses have evolved around portfolio management and the successful investment patterns change from time to time.

Investment decisions are critical to the individual as well to the organization as they can seriously impact their financial status and their future operations also. Employment of a fund management strategy impacts the overall performance of the portfolio in terms of liquidity, profitability and diversification. So the mission of investment managers is to configure a multi-asset class investment opportunities that ensures diversification of investment risk and ensure long term profitability and liquidity maintained. However, the investment in multi-asset class investment cannot always be accepted as the best option by some of the portfolio managers. A structured portfolio also maintains the different roles and responsibilities in the policy statement to ensure proper governance, method of management of the investment segments. However, the general objective of an investment strategy beliefs adopts a particular style of investment basing on the expertise and beliefs of the fund manager. So among the several other options available under financial operations, Passive vs Active money management is one area of interest to many investors.

Statement of the Problem

The current paper tries to identify the historical perspective of the Active vs Passive money management. In other terms, the paper tries to observe which method of practice stands suitable for high profits and which method is suitable for the long term returns.

Objectives of the Research

The current paper tries to achieve the following objectives:

To observe why it is passive or Active money management
To observe the Importance of Active vs Passive money management strategies in fund management
To understand the debate on Active vs Passive money management
To evaluate why it is a concern to debate on Active vs Passive money management
To evaluate the historical perspective of the Active vs Passive money management
To evaluate the difference in fund performance between Active vs Passive money management

The importance of the research

The issue of active and passive money management is a common subject in the realm of financial economy. A successful portfolio needs to evaluate the pros and cons of the different asset classes, not only by looking at their face value but also by the historical analysis. The study can make importance to the Investors as well to the Investment Advisors in a sense that the fund consultants hold the responsibility to guide their clients through the important financial investment challenges they are facing. By being thorough with the investment thought process, an advisor can guide their clients to the maximum value of the fund for return, risk and for future pay within their budgets and expectations. In order to pool the knowledge on the investment patterns, the current paper tries to evaluate some of the concerns expressed by different researchers and scholars on the issue of historical perspective of Active vs Passive money management

Research questions

The research tries to answer the following questions:

What is meant by Active vs Passive money management
Why it is a concern to study Active vs Passive money management
When do the financial experts adopt each method?
What are the cost involved in each of them?
Advantages and Disadvantages of adopting the Active vs Passive money management practices
Role of managers in Active vs Passive money management
How the historical performance of money management altered with Active vs Passive practices?
Which among Active vs Passive money management practices does really pay in short and long runs?

Scope of the study

The current study adopts the observation of facts through the available literature review. The study under its limited scope cannot perform an real time data investigation, and hence depends on the facts put forward by other prominent researchers and studies.

Rationale for the research

The benefits accumulated from active and passive investment methods are well observed by various researches and are also been highlighted by different writers. Each method has witnessed success at different intervals of time. So it is imperative to see which conditions promote the success of each method in the light of timeline.

Methodology

Rationale for Deductive Approach

The current study proposes to observe a deductive approach as it starts the research with a more generalized concept and runs toward a specific observation. The observation of effectiveness of intervention against battering is found out through logical argument and analysis of various theories and examples from literature. This approach can be termed as “top-down” approach. The research begins with a concept or theory then narrows down the search to specific hypotheses to test further. The approach further narrows its scope while observing to address the hypothesis. Finally, the study narrows down the process of observation by further testing the hypothesis to confirm the validity of the data with reference to the original theory and hypothesis. Deductive approach seems narrower in nature at the beginning and is concerned with testing or confirming hypotheses.

Qualitative Method

Qualitative method is used to collect the secondary data to evaluate the preliminary facts of test scenarios and suits. Through qualitative study the general software behavior and their possible outcomes in different test scenarios can be understood by looking at the available Literature. Qualitative research methods can be described as naturalistic, anthropological, and ethnographic and can be used through interpretivism paradigm in the current research. As Byrne’s (2001) definition, qualitative research is about ‘inquiries of knowledge that are outside the framework prescribed by the scientific method, as well as assumptions of inferential statistics’, the current study inquires the knowledge of Regression test cases. Though, qualitative study is assumed as ‘vague’ (Byrne) and ‘loosely defined category of research designs or models (Preissle). The same authors again confirm that qualitative method is a tool that “elicit verbal, visual, tactile, olfactory, and gustatory data as descriptive narratives like field notes, recordings, or other transcriptions from audio and videotapes and other written records and pictures or films” (Preissle 2002).

Qualitative research methodology includes the types like, action research, case study research, Delphi studies, grounded theory, life histories, content analysis, hermeneutics, or general narrative enquiry or participant observer research. Qualitative methods are the most certainly appropriate option when in need of researching patterns and trends in the industry and to understand the depth of the environment around the research point, the cultural characteristics that influence the industry especially when the research is adopting new areas of identification. Qualitative research is ‘mainly concerned with the properties, the state and the character’, (Labuschagne 2003).

Qualitative research also gives the flexibility of driving the research according to the scope. This aspect is very helpful where the research area is very vast and the scope of the research needs to go in particular direction. That’s why qualitative methods are being preferred in studying the sensitive subjects. The personal skills of the researcher bring out the quality in answering the questions of hypothesis. However the personal skills of the researcher may also become hindrances to elicit the exact answers from the responders as it may be influenced by the gender and ethnicity of the researcher.

Qualitative methods allow openness in conducting the research and help to generate new theories. Participating subjects can discuss issues that are important and relevant to the scope of the research, rather than responding to closed questions, and there is a lot of space to clarify ambiguities and confusion over concepts. ‘It certainly seems reasonable to suggest that one may have a better understanding of a community member situation by reading a descriptive passage than just looking at demographic statistics’, (Kruger, 2003). Qualitative results are difficult to total and are difficult even to replicate due to the lack of structured design and standardized procedures. However, the qualitative study gives a greater depth in understanding historical perspective of Active vs Passive Money management.

Qualitative research methodology includes the types like, action research, case study research, Delphi studies, grounded theory, life histories, in-depth interviews, content analysis, hermeneutics, or general narrative enquiry or participant observer research. Qualitative methods are the most certainly appropriate option when in need of researching patterns and trends in the industry and to understand the depth of the environment around the research point, the cultural characteristics that influence the industry especially when the research is adopting new areas of identification.

The current paper adopts the content analysis of the literature review available on the historical perspective of the money management. As the current scope can not draw an output by experimenting on something due to the time and data constraints within the scope of the research, it is validated to follow the content analysis.

Background

Equity investment management can be understood under two types of asset management, they are – Active money management and Passive money management. The managers who try to strike stock market averages are known as active managers. And such fund management practice is called active money management. And the other type of management which do not try to pick stocks to beat the market averages is known as passive money management. The managers who practice such fund management are called passive managers.

The passive money managers proceed to buy the market on an assumption that there is an efficient security market. Where as, an active money manager assumes that the security markets contain inefficiencies which can be capitalized upon investment. The Active money management believes that securities can be mis-priced and they can give excess returns at any point of time based on valuations, buyer behavioral patterns, growth potential, momentum in pricing or any other economic factor.

Active management can be said as the art of stock picking and market timing. Where as Passive management refers to the buy-and-hold approach of money management. The active money management draws the insight to pick the stock basing on the research The research into the financial data by traditional investment firms, portfolio managers, economists, research analysts produce the trading data on companies, industry groups, business conditions, and political developments and scrutinize the facts to present them worth to convince the investors. The research output data informs the investors on which company stocks to buy, Which way is the market headed during a particular period, What micro level economic or commercial condition scan influence the day high and day low trade etc.

Passive Money Management includes the various asset classes like – large cap, mid cap, small stocks, foreign bonds, value or growth assets, etc., Neither label, “active” or “passive,” is perfect, and there will not always be a complete dichotomy between them. In any event, this is a debate about both market behavior and investor behavior.

Passive management: While investing, passive management strategies do not try to judge the efficiency of the stocks among the other stocks. Instead, they as a rule invest in almost all the stocks in the stock market, or they invest in all the stocks in some subcategory according to the index. So this passive money management is also called “indexing”. The portfolio of the active money manager is dependent on the performance of the chosen and allocated submarket performance. This makes the performance of the investment neither to beat nor to fall short of the market index, except for a small fee.

However, it is not a rule of thumb for the passive money investors to strictly invest according to the index; instead they can have the funds allocated in the best possible diversification. But the passive manager is not supposed to pick the stocks or to put a time to take out the investment from the stocks of the market segment.

Active managers pick the individual stocks. They do a lot of research on the whole stock market to decide upon when to get into and out of the stock market. An active manger also decides upon the allocation of individual market sectors for the portfolio. Active management tries to differentiate stocks that will perform poor or best and identifies the particular stocks that yield higher future rates of return in the market and invest in them. The active money management is also a costly affair as it needs lot of information on the fund behavior and growth, market trend analysis and predictions. And hence sometimes, the active money managers need to buy the outside investment research and has to pay huge amounts to financial consultants in the form of wages to get higher profit margins on their investments.

However, for institutional investment funds as the funds are usually larger than individuals’ assets, the cost for active management is lower than for individual investors.

Why It is a concern

In general, active management involves more trading activity and analysis than passive management. This requires more education, effort and time to deal with Active money management than the Passive money management. The higher trading commissions and capital gain taxes may result the higher management fees and return requirements for the active asset management.

The idea of active management is not invulnerable from debate. Passive managers remind that active money management recurrently fail to beat their benchmarks, so they inquire about the reliability of active management practices in following the index and the trends. However the prominent areas of variation in though between active and passive managers are not functional but are theoretical.

Many passive managers adopt the efficient market hypothesis, which prompts that the stock prices are random and are reflecting the most existing and available information. Another theory called the random walk theory, claims that it is impossible to consistently outperform the market, within the short term, due to the fluctuations in stock prices.

In spite of the large attraction of the investors, the active management fails to produce a consistent performance of the invested funds above the benchmark. And most of the analysts recommend the passive investor to get educate about the active investment methods at least to know how to read the stock market charts to make the benefit out of the trend.

Bernhard silli is a money market expert and explained about how investors’ behave under various conditions. The writer has introduced the topic and explains the importance of diversification. The theory of diversification in institutional investors was the central theme. Bernhard silli argues that in most institution investor diversifies their investment because of the engagement in passive management in connection with the portfolio construction. Still, Bernhard silli stresses on the importance of information to attain good payoff to the investors.

Aggressive investor always would search for information in order to improve future payoff and reduce diversification. Active investors understand that the future cash flow is higher where there is opaque information. Therefore these managers try to work hard in order to get information that will enable them understand the future trends.

The writer, Weston J wellington has defined active and passive mangers in fund management. He has gone ahead to give passive management perspective in relation to active management and has succeeded. He has defined active mangers as those managers who gone around looking for investment which has the normal or average returns. He has also defined that active mangers go for stocks of corporation with sustainable growth in terms of profitability and liquidity. This is aimed at ensuring that the portfolio investment is stable.

Larry Nakamura explains that active management involves active human intelligence in assessing the attractive investment. It is the modern method of management which is employed by most managers in selecting mutual funds, bonds, stocks and other investment that generate profitable returns. The main objective is to make profits like passive investors but their intention is not only to accept average returns but also to have huge market returns.

Rex A. began a debate about active and passive management by describing efficiency market theory. He stated the market price of a share is a result of information available to all investors. The theory further states that any new information will concurrently be reflected in the security price therefore it becomes difficult for any investor to outsmart others.

The writers, Noel Amenc, and Lionel Martellini states that early 1990s there was an agreement among academicians that passive was one of the best methods because of efficient market theory. The theory of efficient market states that the price of a security is a reflective of all information available in the market in relating to it. This theory means that investors cannot make a research on extra information that will assist them make extra profit as compared to what is available in the market. However, the active money management recognizes the fact that there is always inefficiency in the market which affects the price. This will help active managers to capitalize on research to acquire superior information which will eventually translate to extra profit.

History of the Active vs Passive Money Management

Argument about active management vs. passive management began in the early 1970s. The differences in the forecast and actual results of the past and future prices has led the researchers to concentrate on the Active vs Passive money management to earn profits. The fundamental data helps the market forecasts by reflecting quickly on the prices. The professional money managers cannot use such information to beat the market in a swift time.

The foremost bond market performance study was conducted in 1977 study of bond market performance. The researchers, Blake, Elton and Gruber examined nearly 361 bond funds to compare the various active funds with simple index strategy alternatives. The authors found that the active funds underperformed with the index by 85 basis points in a year. Depending on the benchmark, between 65 – 80% of the funds performed negative by making an excess.

The researchers, Elton, Gruber, Hlavka and Das observed the functioning of 143 equity mutual funds for the period of 1965-1984. When these funds compared with the set of index funds like, big stocks, small stocks and fixed income whose behavior resembles with the mutual funds, they under perform the index funds by a huge 159 basis points a year. The study did not observe the positive performance of single fund.

In another study conducted by the University of Chicago, Mark Carhart studied a total of 1,892 funds for a period of 1961 and 1993. An equal-weighted portfolio of the funds underperformed by 1.8% per year after an adjustment for the common factors in return

. All these historical studies specify uncover the myths of the efficiency of the active money management. The beat the market effort is not realizing the profits as expected. The market with its own fluctuation is taking the control of the investment pattern.

Advantages of Active Money Management

The advantages of the active money management are as follows:

In an actively money management, an investor gains the expertise in portfolio analysis and investment patterns.

Also the fund managers of this choice can get an advantage of making an informed decisions basing on the market trends, cultural and market patterns, economic, regional plays and the previous stock performance.

An actively fund management with its all due diligence can produce profits by performing over the bench mark index. Whereas a passive strategy suffers from net of fees, and can be expected to under-perform the index with the expense ratio.
The Active money management, the performance can be expected to be altered by the economic conditions in an optimistic way. Where as, passive money management can only be expected to dependent on indexing.
Flexibility: The managers can take rapid changes in the asset management, if they perceive any risk with the existing pattern.

Disadvantages of Active Money Management

Due to the requirement of much research and proficiency for fund management, this results costly with high operating expenses
robability of unpredictable risk: As financial sector is vast, no manager can predict the growth and trends of the asset exactly. So mistakes can happen at point of time.
Personal bias of financial investment style: Each manager has his own way of investment style, which may go parallel or against to the market advantage, this may sometimes result in losses.

Advantages of Passive Money Management

The operating expenses are low for passive management due to the less and non aggressive trading
Decision making burden is not upon the head of the fund manager, as there is no activity involved regularly.

Disadvantages of Passive Money Management

The performance of the funds is controlled and dictated by the market index.
There is no direct control to the investor on the fund performance, as it cannot be retracted and reinvested like active funds.

Is Passive money management lags behind

The passive approach is a newly evolved money management practice whereas the active money management is an age old practice. There are many academic theories developed during 1950s and ‘60s to support the passive asset management. Rex Sinquefield, who is a trust officer at American National Bank in Chicago, developed the nation’s first stock index fund in 1973. Sinquefield being the co-chairman of Dimensional Fund Advisors Inc., was one of the worlds’ leading innovators and a consultant for passive invest management.

The ’90’s wave of market “prosperity” resulted expensive for investors after the market max out in march 2000. For the next two years, investors received a negative impact on their portfolios.

Those highest investors in the large capital segment faced severe losses. During the same time, the average active large capital investors were able to sustain the crisis than the passive investors.

Active management provides the opportunity to counterbalance the economic crisis and losses allowing the money managers to adjust the portfolio to mitigate and manage the risk.

Since 2001, many investment management firms have pushed passive investment strategies making the investors and themselves to believe that markets are highly efficient and the security prices are determined by all appropriate financial data.

During this time the Passive money management industry was operated under the assumptions like:

All financial Information is readily available to all market participants;
All market participants act on that information;
All investors are balanced.

Though these assumptions may seem reasonable in theory, they often fail in practice and are susceptible to behavioral biases of the market which are beyond comprehension of any other theory.

“Over the last ten years, the passive index fell in the top 18% of the large cap active management universe. Therefore (be careful when an advocate uses a scientific term like therefore) 82% of all money managers in this large cap universe under-perform the market averages, and therefore passive investments will produce better results than active investments.” (Wealthcare Capital Management)

David B. Loeper cites some of the arguments that can happen between the Active fund managers and the passive fund managers as presented below:

Passive fund managers argue that only 18% of the 200 funds in the large cap universe exceeded the market’s return during the last ten years.

To this the active fund managers reply saying that “it is obvious that low expenses do not matter because only 7 of the 36 funds (19.4%) that beat the market over the last ten years had expense ratios of less than 50 basis points” (David B. Loeper).

Reverting back the passive fund managers argue that “your analysis is flawed because 33 of the 36 funds (91%) that beat the market over the last ten years had expenses below the category average”, (David B. Loeper)

Answering on the return on investment, the active fund analysts say that these returns are receivables after expenses, not what you pay in expenses”,(David B. Loeper).

Such arguments are never ending as long as the investors can support their returns.

However, the market can see only a 10%-20% of active money managers that are really doing good with all the financial management information at hand and are able to beat up their benchmark index for a period of 10 years.

There is also a possibility of misrepresentation of the statistics associated with the activity of actively managed currency in practice. Some evaluations use a simple average of the performance of large and small cap fund management; where others use the performance of the only median active manager. While the results of this kind of comparison are, in principle, uncertain and cannot rely on them complete to assure the performance.

But Jonathan Berk, gives some insights on why active management can also fail as success and disrepute crawls. When the efficient active asset manager attracts the investors, he receives money that influences his performance for better investment, and the drive of expected income reduces leaving the edge for the 2^nd best manager. When people try to equate between the 1^st best and second best managers, they be come rich and eventually their drive for best allocation diminishes leaving the gap for the 3^rd best manager. So the investment pattern changes with the time line and if the investors are not couscous of such changes, they may be falling in the market ignorance for losses.

Also when a fund starts it takes a rocket speed to reach high but when it becomes successful the pace slows down. Most investors just go by sight and result in poor returns after some time.

Implication and recommendation

Though different in theory and concept, both Active and Passive money management practices are meant to assist the portfolio management. Good management style is meant to assessing the profitability of entity. The efficiency of a an investment practice can be measured by the way brings returns in the short and long run.

The adoption of the active vs passive management portfolio is also dependent on the management style and objectives of the portfolio for short and long terms. However, an active asset management gives the flexibility to alter the investment pattern during the rough conditions, whereas the passive investment patterns are not flexible to such option.

The current research helped the investment managers to know the strength of each management style, the risks involved in it and when to choose the option and how the profit can be assed with reference to expense.

The above study found some of the assertion which drives the fund managers to make the Passive vs Active money management decisions.

Though Fund management can be termed as an art rather than science, the mathematical calculations involved in the active asset management are not going to be in vain. The careful research and investment plan are sure to return.

In order to choose the active management, some managers think in terms of cost rather than profits. The reason is operating expenses and the payments to the active managers are costly and are to be pad out of the profits earned on the investment, which sometimes exceeds to make the profit lower than the passive money management in some occasions.

The expense to profit ratio is the major key concept in choosing the fund strategy. However, some mangers tally it with the time and duration involved in profit realization. Also in reality, the Passive money management is not truly passive in nature, with evidence that some passive fund managers do sampling for market choice before investing which is none other than market research. Similarly active managers do not always do aggressive investment and can represent non passive component. With time, the Many times when the investors cannot gauge into the expertise of the fund manager, they pay much higher than what exactly required. The performance of the institutionalized investment manager is different to the non institutionalized fund manager.

Also the debate on Active vs Passive money management gives the fund managers a challenging situation to decide upon. When a manager is given a choice to decide upon the best investment practice he starts thinking outside the box. His approach to issues changes. He improves his perception on problems involved in fund management and will eventually improve the profitability by mitigating them.

Recommendation

Because the two management styles looked into and one has bee used mostly in past while the other has limited use it will be very difficult to determine whether it is prudent to recommend one as superior than others. It must also be acknowledged that what is written about two is subjective and may different from true practice of fund managers. It is also not always possible to be certain that it gives a fair reflection of the way things are in real life.

However from the above literature review it is understood that Active money management always looks to beat the market price and is a sure one to gain profit in the short term. But consistency in profit is not a promise with the active asset management. Though it was no the whole responsibility of the investment practice,

It can be assumed that a poor education or research after a while of the fund performance makes the investors slack and turns the profits off.

Where as the passive management being less risky yields steady profits in the long run. Both being the tools of money management, portfolio analysts suggests the investors to observe the two different practices at different times with utmost care and thorough knowledge.

Though the current study cannot find an overall yes or no answer to investment practices between Active vs Passive money management, there are a many of valuable observations that can be summarized from the report for professional consideration.

References

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Joseph Chen & Harrison Hong & Ming Huang & Jeffrey D. Kubik, 2004.

“Does Fund Size Erode Mutual Fund Performance? The Role of Liquidity and Organization,” American Economic Review, American Economic Association, vol. 94(5), pages 1276-1302.

Laurence B. Siegel, Benchmarks and Investment Management, 2009, Web.

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Rex A. Sinquefield, Active vs. Passive Management, 2009, Web.

Timothy F. Bock, Active versus Passive Management: One of the Most Important Investment Decisions, 2009, Web.

Rex A. Sinquefield, Active vs. Passive Management, 2009, Web.

David B. Loeper, Active vs. Passive Management: The Debate Continues, 2009, Web.

Rex A. Sinquefield , Active vs. Passive Management, 2009, Web.

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Weston j, Active vs. passive management, 2009, Web.

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Passive vs. Active Investment Management Strategies: Comparisons, Perspectives and the Relevance to Financial Advisors, Journal of financial Planning, Web.

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