Active asset management versus passive asset management

Topic 1: Active Asset Management versus Passive Asset Management.

I.

INTRODUCTION

It is true that the issues related to a passive investment strategy versus an active investment have
become one of the most controversial issues of both academics and investors. This essay will
analyze the principal problems and offer some personal insights on both methods
1. Active Investment Strategy
Portfolio management in an active way is based on analysis of securities combined with the
macroeconomic situation of portfolio managers. Investors or fund managers will analyze the
business situation of the companies, the macroeconomic situation is analyzed carefully and
frequently to select stocks with high growth potential in the long term.(Mauboussin, 2001)
Active investment means that investors can decide to stop trading when the market shows signs
of uncertainty or sell orders if the market is in crisis, investors not only survive the storm but also
profit from it.
Often in underdeveloped or unsustainable markets will have the best chance of making a profit.
Portfolio managers try to buy low-priced bonds, hold them until prices rise and sell these bonds
to maturity for arbitrage.
Such aggressive investment is much more flexible than investors simply buying and holding
stocks. In short, active investment management attempts to “beat the market.” The goal of active
management is to take full advantage of short-term price fluctuations and try to determine where
and when that price will change. (Andrew Ang, 2010)
2. Passive Investment Strategy
Unlike active portfolio managers, index managers can’t sell poorly run companies. They must
buy every stock in a given index and keep it as long as it stays in the index. As a result, index
managers typically own a broad swath of the market and often hold those stocks indefinitely.
This encourages them to focus on issues that could have a bearing on shareholders’ outcomes
over the long-term.(Morningstar, 2014)
This strategy is most commonly understood as a buy-and-hold strategy where investors buy and

hold securities for a long time, during which time they almost had no adjustment or minimal
adjustment of the that portfolio.
Passive strategy is encouraged by Efficient Market Hypothesis of which there are three versions
(Fama, 1965, 1970). The weak form means pass informations reflect on current price (based on
information in the past, the speculators did not beat the market). The semi-strong form says stock
prices have been fully affected by information disclosed in the past and information has just
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announced. Thus, speculators can not rely on that information to be able to buy low sell high, as
soon as the information is published, the stock price has changed. The strong form of this theory
further confirms the effectiveness of the financial market that the price of the stock reflects all
past, current and insider information. Followers of EMH do not controvert that actively managed
funds can beat passively managed funds, this would only happend through short-term luck and
could not be systematically achieved, especially net of investment and trading costs, however.
For instance, 230 mutual funds were investigated by Bollen and Busse (2005) and they found
any superior performance disappeared after one year from 1985 to 1995. Carhart (1997)
discovered the same result for 1900 mutual funds studied from 1962 to 1993. Therefore, there is
no need to look for the wrongly priced securities and buy and sell securities actively. Investors
who pursue passive strategies often diversify their portfolio to make their portfolio match a stock
index.
Consequently, passive strategies are often referred to as match-index strategies. The most purely
passive strategy is to strategically match the index completely. According to this strategy,
investors will choose a benchmark such as the S & P 500. Their portfolio has fallen exactly as
the S & P 500 index is falling. For example, Apple accounting for 22% of the S & P 500 index ,
the portfolio also holds 22% of Apple. In Vietnam, VN-Index, VN30, VN100… will be selected
as a benchmark.
3. Investment trends in the world
David Swensen is an investment expert, author of several books and former investment manager
of Yale Investment Fund. He is a prime example of index investment. In his book

“Unconventional Success”, published in 2005, he writes “Most individual investors lack of the
expertise that needed to succeed in in the increasingly competitive investment market today. As
a result, passive index funds are the best choice for these investors".
Index mutual funds are a simple and almost safe investment method cause investing in many
market segments, spreading risk.These funds are often used by investors who have a little
experience or skilled investment professionals with large portfolios.
There are several seminal publications supporting passive investment strategies. Treynor (1965)
pioneered the idea of measuring and incorporating risk in the calculation of investment returns.
Sharpe (1966) and Jensen (1968) performed the early tests of comparing the returns of active
mutual fund managers to the returns from a broad passively managed portfolio, such as based on
the Dow-Jones Industrial Average. Sharpe (1966) concluded actively managed portfolios yielded
no consistently superior performance after deducting management costs. Jensen’s (1968) results
were even bolder—actively managed funds could not provide superior returns even if
management fees were zero. Fama and French (2010) extended Sharpe’s general findings for
more recent mutual funds. Malkiel (2011) has touted passive investment strategies by showing
how a diversified mix or investments representing all major economic sectors yields higher after2


cost returns over long investment periods. Asebedo and Grable (2004) found that paying for
active management through mutual funds with higher fees yielded inferior performance
compared to the returns from funds with low fees.
Index mutual funds are a simple and almost safe investment method cause investing in many
market segments, spreading risk. These funds are often used by investors who have a little
experience or skilled investment professionals with large portfolios.

figure 1: investors choose index funds
Morningstar notes that the amount shovelled into passive funds in 2016 was more than four
times that of active funds. (Research, December 2017)Passive investing has become a hot issue.
In present, accounts for a larger share of publicly traded assets.

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figure 2: Surveyed Manager AUM Split Into Passive and Active ($ Billion)
The table above illustrates three biggest asset managers which are BlackRock, Vanguard, SSGA
seem to like passive inesting rather than active investing. More than half of their assets are
passive.

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Figure 3: 7 Funs to Beat the Index
According to Mark Carhart (1997) study of large US mutual fund showed that mutual fund only
beat the market 1/3 time, also according to Morningstar research (2017) (Figure 3), so far only
about 7 mutual funds can beat the market.

Figure 4 : Global Fund Assets Split Into Active and Passive ($ Trillion)
In august 2017, according to ETFGI advisory firm, demand for ETFs rose sharply this year.
(Figure 4) During the period January-July 2017, investors injected $ 391 billion into ETFs,
surpassing a record $ 390 billion last year. Thus, index funds have attracted nearly $ 2.8 trillion
since the beginning of 2008. Although passive investment is becoming more popular in the
world, Global Fund Assets Split Into Active and Passive increasing, only about 25% market
funds.

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4. Active vs Passive Investing - strengths andweaknesses


Active Investment strategy.

There are two main advantages of active investing. Firstly, investors may have the opportunity to
earn potentially market-beating returns.(MadisonFund, July 2, 2012.)Active investors believe
that they can beat the market by predicting trends and investing in hand-picked stocks.
Secondary, investors can flexibly diversify their portfolio. They can easily change their porforlio,
look for better stocks, or easily make a sale or still hold decision on a stock that is not good.
However, this investment still has some shortcomings. First of all, human error. No matter how
good fund managers are, there is no denying that they will make mistakes and that they will not
always be able to beat the market. Next, active ivestment have high cost. Whether or not to
create a return, active fund’s clients still lose a certain amount of fee. Even if those funds make a
return, investors will also have to deduct a percentage of the fees and commissions. The average
actively managed stock fund, incurs annual expenses of around 1.3%, or $1.30 for every $100 an
investor has in the fund.(WhartonSchool, Feb 02, 2011)


Pasive Investment strategy.

Compared to active methods, passive methods seem to have more advantages. Personally, a
passive investment strategy has six advantages. Firstly, easy investment.Large funds in the
market make it easier to distribute and diversify assets. Secondly, better quality management.The
passive nature of index investment helps to eliminate mistakes made by managers as in active
management mutual funds. Thirdly, Investing in indexes is far less costly than active fund
management. In a letter that Warren Buffett sent to shareholders of Berkshire Hathaway Inc on
March 25, 2017, he pointed out that in the past 10 years, investors have wasted $ 100 billion on
fees, while interest was belong to the managers instead of their customers. Investing in the index
requires less stock trading, thus reducing the cost of taxes and other expenses. Lastly, The
investment performance of index funds outperformed active investment funds in the long run.
Over the 23 years finishing in 2009, while actively managed funds trailed their benchmarks by
an average of one percentage point a year, an index fund would have returned between 9.8% and

9.9%, with a small amount for fees. (WhartonSchool, Feb 02, 2011)
Although there are many advantages, passive investment still has certain limitations. Limited
return is the first weaknesses of this investment. Investors who choose this investment strategy
will only get a low return even when the market is in a state of turmoil (because this strategy can
not beat the market). Secondary, less opportunity than active management. Passive investment
strategies are overly focused on large caps, which mean that the other stock could not be found.
Returns can be affected by political conditions or regulatory events. Lastly, volatility in

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investment. Returns can be affected by political conditions or regulatory events; investor must
always follow on stock market movements and worry when values drop
5. Investment strategy in Vietnam
Refer to the Vietnam’s stock market. The stock market in Vietnam is a new market compared to
other developed countries in the world. However, in the past 10 years, the stock market in
Vietnam has become more active, investors have also begun to learn investment methods in the
world, including two main investment procedures being Investors and hedge funds are active
investment strategies and passive investment strategies.

Investmen funds in Vietnam 2018

24.32%

2.70%
5.41%

62.16%

mutual fund 

fund certificate
Vietnam Equitization Focused
Member Fund
ETF
real estate funds

5.41%

Figure 5: Investment Funds in Vietnam 2018
Source: State Securities Commission of Vietnam
According to State Securities Commission of Vietnam, as of 31/01/2018, Vietnam has 37 funds
(Figure 5), of which only 02 ETFs account for 5% of the total funds in Vietnam. So why does not
ETF grow in Vietnam?
Passive investment depends on effective market theory as I mentioned above. However, does the
Efficient Market Hypothesis work in the real world? Figure3 presents 8 studies on the weak form
of the Vietnam stock market from 2000 to 2013.
Figure 6 : Studies on the weak form of the Vietnam stock market over time
20002005200720002000200020092005
2008
2010
2009
2011
2013
2012
Truong Dong
x
authors

20092013
7

Loc
Pham Vu
x
Thanh Long
Vuong Duc
x
Hoang Quan
Nguyen Thu
x
Hang
Nguyen Thi
Bao Khuyen
Frances Guidi
& Rakesh
Gupta
Phan Khoa
Cuong
Le Chung
Thanh Thao
Source: National Institute for Finance

x
x
x

o
o

'' x 'is negative for effective market existence,' o 'is to confirm the existence of effective markets
in vietnam for the period 2000-2013.
According to 8 studies of 8 different authors on the market in Vietnam for the year 2000-2013,
only two studies have identified Vietnam as an effective market. That indirectly reflects the
passive investment form in Vietnam is not effective.
Moreover, the psychology of Vietnamese investors is often too confident and susceptible to
fluctuations in the market.(Hien, 2012) Thus, active investing is preferred in Vietnam due to the
flexibility of portfolio changes.
6. Conclusion
In summary, it is impossible to say with any certainty what kind of investment would make more
money. The answer depends on the risk appetite as well as the preferences of each investor. More
importantly, at different times; investors will make different investment decisions.
In a recent speech, Warrent Buffet tended to favor investing in index funds and praising passive
investment. He argues that active investment strategy costs too much and that return is not high.
"Continuing to buy the cheap S & P 500 fund is something that I think is the most realistic at all
times." he shared on CNBC. However, if only choose a passive investment strategy that does not
use active investment strategy, it is no different than gambling. Passive investing is best suited to
longer-term investors who are happy to leave their money in place for at least a few years.

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Therefore, investors in the world always give priority to active investment funds in real. The
stock market is getting more volatile with a lot of ups and downs and investors are hoping to find
a “Black Swan event” that can beat the market. In addition, many investors find that active
investment is an attractive investment strategy in certain market segments where the market is
ineffective, such as investing in stocks of small cap.

Return to Warrent's speech and look at the reality, he became a billionaire when he beat the
market with active investment rather than investing in indicators. When he had the extra money

after that, he put a few into the index funds to get a certain return every year.
I would personally choose a passive investment strategy for bluechip stocks when the stock
market is stabilizing. But will divest capital into active investment when seeing signs of market
abnormalities or other intangible political events that affect the market in general.
.
7. References

1. Fama, E. (1965). The behavior of stock market prices. Journal of Business, 38(1), 34-105
Fama, E. (1970). Efficient capital markets: A review of theory and empirical work.
Journal of Finance, 25(2), 383-417.
2. Fama, E., & French, K. (2010). Luck vs. skill in the cross section of mutual fund returns.
Journal of Finance, 65(5), 1915-1947
3. Jensen, M.(1968). The performance of mutual funds in the period 1945-1964. Journal of
Finance, 23(2), 389-416.
4. Asebedo, G., & Grable, J. (2004). Predicting mutual fund performance over a nine-year
period, Journal of Financial Planning and Counseling, 15(1), 1-11.
5. Research, M. M. (December 2017). Passive Fund Providers Take an Active Approach to
Investment Stewardship
6. Le Chung Thanh Thao (2012), Efficient Market and Signaling Hypothesis on Vietnam
Securities Market 2009-2012”, Việt Nam: Hồ Chí Minh.
7. Nguyen Thi Bao Khuyen (2010), Stock prices and macroeconomic variables in vietnam:
an empirical analysis, Vietnam - Netherlands project for m.a in developing economics.
8. Phan Khoa Cương (2013), Market efficiency in emerging stock markets: A case study of
the Vietnamese stock market.
9. Truong Dong Loc (2006), Testing the Weak-Form Efficiency for the Vietnamese Stock Market, Netherlands Journal
10. VOICU, A. passive vs. active investment management strategies.
11. Carhart, M. (1997). "On Persistence of Mutual Funds." The Journal of Finance, Vol.52,
No. 1, 57-82
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12. ANDREW ANG, W. N. G., STEPHEN M. SCHAEFER. 2010. The Efficient Market
Theory and Evidence : Implications for Active Investment Management [Online].
13. HIEN, D. N. D. 2012. Investor psychology in the financial market in Vietnam.
14. MADISONFUND July 2, 2012. THE ADVANTAGES OF ACTIVE MANAGEMENT.
15. MAUBOUSSIN, A. R. A. M. J. 2001. Does It Pay to Be active Investor?
16. MORNINGSTAR 2014. Active Passive Strategies.
17. RESEARCH, M. M. December 2017. Passive Fund Providers Take an Active Approach
to Investment Stewardship [Online]. Morningstar
18. WHARTONSCHOOL, T. Feb 02, 2011. If Index Funds Perform Better, Why Are Actively
Managed Funds More Popular? [Online]. Available:
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