Active mutual funds rely on trading decisions to increase returns
Definition/Example of Active Mutual Funds
An active mutual fund, or an actively managed exchange-traded fund (ETF), is a fund that relies on the decisions of an investment manager or a team of managers to determine the assets that the fund holds. The goal is to outperform passive mutual funds, which match and track an asset index like the S&P 500 or the Nasdaq Composite Index.
Active mutual fund managers typically adhere to a specific investment strategy outlined in the fund’s prospectus, but they have the flexibility to buy and sell investments based on their research.
Although active mutual funds represent the majority of fund assets in the long term – about 60% at the end of 2020 – index funds have more than doubled their share of fund assets in the long term since 2010. The popularity of passive mutual funds has increased as more investors learn that these funds generally outperform active mutual funds and carry lower management fees and costs related to portfolio turnover than active mutual funds.
How Active Mutual Funds Work
Investors who wish to attempt to outperform market indices can choose their own stocks or invest in active mutual funds. Some investors rely on a combination of passive mutual funds and active mutual funds.
Active mutual fund managers are usually supported by a team of investment analysts. The performance of an active mutual fund is typically measured against a benchmark that closely reflects the fund’s investment strategy. Performance can be found over various periods such as one year, three years, and five years in the fund’s prospectus. The prospectus will also outline management fees and provide information about the fund’s managers, including their tenure with the fund.
For example, the prospectus for the Fidelity Magellan Fund (FMAGX), which was considered a successful fund under Lynch’s management, indicated that as of the end of October 2021, it had returned about 38% over the past 12 months and had an average annual return of about 21% over five years. However, its benchmark, the S&P 500, had returned about 43% in the same annual period and had an average annual return of just under 19% over the past five years.
The majority of active mutual funds fail to outperform their benchmarks. Research performance reports such as S&P Indices vs. Active (SPIVA) published by S&P Dow Jones Indices compare the performances of active equity and bond funds against their benchmarks. The firm reported that about 73% of large-cap active U.S. equity funds failed to outperform the S&P 500 over the past five years. During the same five-year period, about 67% of small-cap active equity funds outperformed their benchmark, the S&P SmallCap 600.
Advantages and Disadvantages of Active Mutual Funds
The debate over whether active mutual funds are better than passive funds will continue among investors forever. However, there are undeniable positive and negative facts about active mutual funds.
Advantages
- They provide average-income investors access to specialized stock pickers
- They can outperform stock indices in the short and long term, sometimes significantly
- Management fees have decreased in recent years
Disadvantages
- Most do not outperform index equity funds
- Past performance is not indicative of future results
- They typically have higher fees and additional trading-related costs
What This Means for Individual Investors
There are varying opinions on whether it makes sense to use active mutual funds when most fail to outperform their benchmarks and come with higher fees. Some investors use active mutual funds for specific sectors, such as biotechnology or real estate, and use index funds for broader categories like large-cap equities or international stocks.
They provide
Most brokers provide easy access to a wide range of active and passive investment funds. When choosing active investment funds, it’s important to conduct thorough research on the management team as well as the fees and costs associated with any portfolio, trading, and operations.
Takeaway
- Active investment funds rely on the research and decisions made by the investment manager or management team to determine the fund’s assets.
- The performance of an active investment fund is usually measured against a benchmark that reflects the fund’s investment strategy.
- The majority of active investment funds fail to outperform their benchmark indices over time.
- Due to their management style, active investment funds routinely have higher costs than passive index funds.
Source: https://www.thebalancemoney.com/what-are-actively-managed-funds-5209430
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