Understanding the Basics of Fund Management
Fund management, also referred to as investment management, refers to the process in which a fund manager uses investor money to buy and sell stocks, bonds, real estate, commodities, and other securities and assets in order to achieve specified investment goals. How a fund is managed is determined by these investment goals, or objectives, as well as which strategy, either active or passive, the fund implements.
An important part of fund management is to identify and meet the fund objectives. These objectives include capital appreciation, current income, and safety of principal, or initial investment. The concept of risk plays a major role in these objectives. Some funds sacrifice safety of principal for more potential capital appreciation, while other funds focus on minimizing risk to the principal by investing in safer, but less profitable, investments. Also, some funds focus on investments meant to become profitable in the long term, while other funds look for shorter term profits, so time horizon is another important aspect in fund management objectives.
ACTIVE VS PASSIVE STRATEGY
An often divisive topic in fund management is whether active or passive fund management strategy is a better approach. A passive management strategy aims at holding a diversified portfolio and maintaining a predetermined level of risk using the principles of Modern Portfolio Theory, and an active management strategy uses these principles as well as the concepts of market timing, sector rotation, and security selection in order to try to earn greater risk-adjusted returns. While an actively managed fund may produce greater returns, there is much research shows that a large majority of actively managed funds underperform equally risky passive funds. Research also shows that past performance does not accurately
predict future performance in actively managed funds, meaning that a fund that previously outperformed similar risky funds will not necessarily do so in the future.