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Active vs. Passive Portfolio
Management
One of the longest-standing debates in investing is in a particular type of security. A fund's prospectus
over the relative merits of active portfolio will outline any such provisions, and you should read
management versus passive management. With an it before investing.
actively managed portfolio, a manager tries to beat
the performance of a given benchmark index by using Passive investing: focusing on costs
his or her judgment in selecting individual securities Advocates of unmanaged, passive
and deciding when to buy and sell them. A passively investing--sometimes referred to as indexing--have
managed portfolio attempts to match that benchmark long argued that the best way to capture overall
performance, and in the process, minimize expenses market returns is to use low-cost market-tracking
that can reduce an investor's net return. index investments. This approach is based on the
Each camp has strong advocates who argue that the concept of the efficient market, which states that
advantages of its approach outweigh those for the because all investors have access to all the
opposite side. necessary information about a company and its
securities, it's difficult if not impossible to gain an
Active investing: attempting to add advantage over any other investor. As new
value information becomes available, market prices adjust
in response to reflect a security's true value. That
Proponents of active management believe that by market efficiency, proponents say, means that
picking the right investments, taking advantage of reducing investment costs is the key to improving net
market trends, and attempting to manage risk, a returns.
skilled investment manager can generate returns that
outperform a benchmark index. For example, an Indexing does create certain cost efficiencies.
active manager whose benchmark is the Standard & Because the investment simply reflects an index, no
Poor's 500 Index (S&P 500) might attempt to earn research is required for securities selection. Also,
better-than-market returns by overweighting certain because trading is relatively infrequent--passively
industries or individual securities, allocating more to managed portfolios typically buy or sell securities only
those sectors than the index does. Or a manager when the index itself changes--trading costs often are
might try to control a portfolio's overall risk by lower. Also, infrequent trading typically generates
temporarily increasing the percentage devoted to fewer capital gains distributions, which means relative
more conservative investments, such as cash tax efficiency.
alternatives. Popular investment choices that use passive
An actively managed individual portfolio also permits management are index funds and exchange-traded
its manager to take tax considerations into account. funds (ETFs). However, some actively managed
For example, a separately managed account can ETFs are now being introduced, and index funds and
harvest capital losses to offset any capital gains ETFs can be used as part of an active manager's
realized by its owner, or time a sale to minimize any strategy.
capital gains. An actively managed mutual fund can Note: Before investing in either an active or passive
do the same on behalf of its collective shareholders. ETF or mutual fund, carefully consider the investment
However, an actively managed mutual fund's objectives, risks, charges, and expenses, which can
investment objective will put some limits on its be found in the prospectus available from the fund.
manager's flexibility; for example, a fund may be Read it carefully before investing.
required to maintain a certain percentage of its assets
December 03, 2012
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2. Proponents of active Blending approaches with asset benchmarks in order to provide a value versus growth
portfolio management bias or a market capitalization tilt.
believe that a skilled allocation
investment manager can While core holdings generally are chosen for their
The core/satellite approach represents one way to low-cost ability to closely track a specific benchmark,
generate returns that
outperform a benchmark
have the best of both worlds. It is essentially an asset satellites are generally selected for their potential to
index. Advocates of allocation model that seeks to resolve the debate add value, either by enhancing returns or by reducing
passive investing argue about indexing versus active portfolio management. portfolio risk. Here, too, you have many options. For
that the best way to Instead of following one investment approach or the example, satellite investments might include hedge
capture overall market other, the core/satellite approach blends the two. The funds, private equity, real estate, stocks of emerging
returns is to use low-cost bulk, or "core," of your investment dollars are kept in
market-tracking index
companies, or sector funds, to name only a few.
cost-efficient passive investments designed to Good candidates for satellite investments include less
investments. capture market returns by tracking a specific efficient asset classes where the potential for active
benchmark. The balance of the portfolio is then management to add value is increased. That is
invested in a series of "satellite" investments, in many especially true for asset classes whose returns are
cases actively managed, which typically have the not closely correlated with the core or with other
potential to boost returns and lower overall portfolio satellite investments. Since it's not uncommon for
risk. satellite investments to be more volatile than the core,
Bear in mind, however, that no investment strategy it's important to always view them within the context
can assure a profit or protect against losses. of the overall portfolio.
Controlling investment costs Tactical vs. strategic asset allocation
Devoting a portion rather than the majority of your The idea behind the core-and-satellite approach to
portfolio to actively managed investments can allow investing is somewhat similar to practicing both
you to minimize investment costs that may reduce tactical and strategic asset allocation.
returns. Strategic asset allocation is essentially a long-term
For example, consider a hypothetical $400,000 approach. It takes into account your financial goals,
portfolio that is 100% invested in actively managed your time horizon, your risk tolerance, and the historic
mutual funds with an average expense level of 1.5%, returns for various asset classes in determining how
which results in annual expenses of $6,000. If 70% of your portfolio should be diversified among multiple
the portfolio were invested instead in a low-cost index asset classes. That allocation may shift gradually as
fund or ETF with an average expense level of.25%, your goals, financial situation, and time frame change,
annual expenses on that portion of the portfolio would and you may refine it from time to time. However,
run $700 per year. If a series of satellite investments periodic rebalancing tends to keep it relatively stable
with expense ratios of 2% were used for the in the short term.
remaining 30% of the portfolio, annual expenses on Tactical asset allocation, by contrast, tends to be
the satellites would be $2,400. Total annual fees for more opportunistic. It attempts to take advantage of
both core and satellites would total $3,100, producing shifting market conditions by increasing the level of
savings of $2,900 per year. Reinvested in the investment in asset classes that are expected to
portfolio, that amount could increase its potential outperform in the shorter term, or in those the
long-term growth. (This hypothetical portfolio is manager believes will reduce risk. Tactical asset
intended only as an illustration of the math involved allocation tends to be more responsive to immediate
rather than the results of any specific investment, of market movements and anticipated trends.
course.)
Though either strategic or tactical asset allocation can
Popular core investments often track broad be used with an entire portfolio, some money
benchmarks such as the S&P 500, the Russell 2000® managers like to establish a strategic allocation for
Index, the NASDAQ 100, and various international the core of a portfolio, and practice tactical asset
and bond indices. Other popular core investments allocation with a smaller percentage.
may track specific style or market-capitalization
Securities, Investment Advisory Services and Financial Planning Services through qualified Registered Representatives of
MML Investors Services, LLC., Member SIPC. Supervisory Office: 530 Fifth Ave., 14th Fl. ? New York, NY 10036 ? 212.536.6000
Sentinel Solutions, Inc. is not an affiliate or subsidiary of MML Investors Services, LLC or its affiliated companies.
Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, or legal advice. The information presented here is not
specific to any individual's personal circumstances.
To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose
of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her
individual circumstances.
These materials are provided for general information and educational purposes based upon publicly available information from sources believed
to be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time
and without notice.
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Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2012