Question

QUESTION FIVE a) Umerentiate between active and passive portfolio management (2 Man b) Explain the two main strategies in passive portfolio management and comme on the effectiveness of the strategies in achieving the desire outcome (6 Marks) c) Suppose two investors have formed portfolios, A and B, designed to track a particular bench mark. Over a period of three vears, the returns to the portfolios as well as the index returns were as follows: BENCHMARK 3.9 4.2 4.7 0.8 0.2 YR QUARTER MANAGED MANAGED PORTFOLIO A (%) PORTFOLIO B (%) 2013 1 2013 2 -3.8 4.8 2013 3 10.5 2013 4 2014 1 1.1 2014 2 3.4 3.5 2014 3 8.9 8.5 2014 4 -0.7 -0.6 2015 1 7.9 2015 2 2015 3 2015 4 0.3 Define tracking error in the context of passive portfolio management. (1 Mark) Calculate the annualized tracking errors for the portfolios for this period and comment on the performance of the managed portfolios? (11 Marks

investment analysis

Answer 1

Active Portfolio Management

1. Active portfolio management emphasis on outperforming the market as compared to a specific benchmark that relates to the assets in the portfolio. Investors who opt for an active portfolio management approach use fund managers or brokers to buy and sell stocks in target to outperform a specific index.

2. Active Portfolio management focus on factors that may affect the performance of specific companies within their portfolio. The main objective being, to avail the advantage of irregularities and miss-pricing. Active managers promote their funds to the market on basis of their own ability to generate greater returns than those returns which are achieved by simply replicating a particular index.

3. Active Portfolio Management is too costly.

4. In a falling market, active managers who invest in shares on the basis of a company’s fundamental qualities are more likely to outperform the broader market.

Passive Portfolio Management

1. Passive portfolio managers select stocks and other securities listed on an index by applying the same weighting to the portfolio as applies to the index. The objective of passive portfolio management is to generate a return that is the similar to the chosen index instead of outperforming it. This investment strategy is not proactive, the management fees are determined on passive strategies are often far lower as compared to active portfolio management strategies.

2. Passive Portfolio management focus on factors that may affect the performance of index on the basis of which the portfolio is formed. The main objective being, to generate the similar return as the index is generating.

3. Passive Portfolio management is cost effective.

4. In a rising market, passive manager who invest in the stock on the basis of Index fund generates high return at cheaper cost.