An active fund is an investment, typically a mutual fund, where managers actively pick companies for you to invest in. Essentially, these managers are professional investors who you hire to invest in companies on your behalf. When you invest your money with an active fund, your money is parceled out among the stocks of companies that these active managers select.
In your typical actively managed mutual fund, active fund managers select a number of stocks. Therefore your money becomes diversified throughout the companies the manager has selected when you invest in a particular active fund.
What can make an active manager better than the average investor?
Aside from having teams of analysts working for them and in my opinion a huge technological advantage, these active managers also often have the ability to gather more in depth information relating to the companies they’re investing in. Many of these managers conduct extensive interviews with officers of particular companies, tour facilities, and review in detail company balance sheets.
Additionally, these managers attempt to take advantage of market trends and utilize risk management when selecting particular companies.
With all of the research and resources at the disposal of these managers, it could be expected that they would have a great deal of insight into the companies that they’re selecting for you; insights that you and I don’t necessarily have access to and insights that could allow these funds to outperform other types of investments.
With all this extra work, how do managers get compensated?
When you invest in an active fund with managers, they typically get paid from what is called a fund’s expense ratio. An expense ratio is a percentage ranging anywhere from roughly 0.20% – 2.00% on up. The expense ratio is applied to the money you have invested with the fund and is paid annually.
To make the math simple we will look the following hypothetical situation. Let’s suppose you have $10,000 invested in a fund with a 1.00% expense ratio, $100 would be deducted from your account and paid to the fund manager for that particular year. This extra money that you’re annually paying to the fund is for the professional management and all the resources they utilize when selecting said investments.
You may be thinking, “So if I hire an active manager with all these resources at their disposal, my investments with them should do really well right?”
Well theoretically yes. You may assume that if you pay the extra cost to hire a professional that the returns on your investment would do exceedingly well when compared to the index they benchmark their performance to. However, this is not always the case.
Some active fund managers fail to outperform their index and thus fail to provide value for the extra money you’re paying.
The Alternative: Passively Managed Funds
In my opinion one of the main goals of active investing is to outperform the market through long-term investment periods. There is the argument that the extra price you pay for a fund manager’s value isn’t warranted. Especially if only a small percentage of these managers actually beat their respective index.
Although a valid point, there still are fund managers out there who have previously beaten their respective benchmark indices over long periods of time. But hey, depending on what you prefer another option which is sometimes more cost effective is passive funds (ETFs and index funds).
This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Any opinions are those of Jacob Dahlstrum and not necessarily those of Raymond James. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Past performance does not guarantee future results. One cannot invest directly into an index. Every investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Diversification and asset allocation do not ensure a profit or protect against a loss. An expense ratio is not the only fee associated with investing in these products. The fees mentioned above are for hypothetical purposes only and can vary greatly depending on your financial situation. Investors should consider the investment objectives, risks, charges and expenses of a mutual fund and an exchange traded product before investing.
The prospectus contains this and other information and should be read carefully before investing. The prospectus is available from your investment professional.
ETF shareholders should be aware that the general level of stock or bond prices may decline, thus affecting the value of an exchange-traded fund. Although exchange-traded funds are designed to provide investment results that generally correspond to the price and yield performance of their respective underlying indices, the funds may not be able to exactly replicate the performance of the indices because of fund expenses and other factors.