Fund management, portfolio management, active and passive management and, unfortunately, mismanagement are all familiar to those associated with the field of investment. But what exactly does "management" mean in a general sense and what is its specific relevance within the investment context? This is an incredibly important question, but one that is seldom (if ever) raised.
John Schermerhorn in his book "Management," writes that "management is the process of planning, organizing, leading and controlling the use of resources to accomplish goals."
Breaking the process down into the above standard four elements is the key to understanding the implications for money management. Any investment process must involve planning, organization, leadershipand control to some extent in order to be considered managed. However, any of these four elements can be done well or poorly, and this will impact returns.
Key Takeaways
- Good management is the process of planning, organizing, leading and controlling the use of resources to accomplish goals.
- In the context of portfolio management, planning and organizing are less problematic areas, but investors tend to overlook leading and controlling.
- To address this, investors can focus more on monitoring, controlling and adjusting the mixture of different types of investments within their portfolios.
Investment Management vs. Management in General
Definitions of investment management are very different from those of general management. For example,portfolio managementis defined as the art and science of making decisions about investment mix and policy, matching investments to objectives, asset allocation for individuals and institutions,and balancing risk against performance. This is a very specific definition of management in the investment context.
However, the four cornerstones of general management still apply in investing and are clearly reflected in the definition of portfolio management. Despite this, there is a tendency for both investment managers and investors to understate or even ignore one or more of the basic general management principles, and this is very dangerous.
For investors, however, planning and organizing are less problematic areas to overlook than leading and controlling. Control, in particular, is the weak point in managing investments, and the true Achilles' heel of so many investments.
Leading and Controlling: The Danger Zones
What makes investors so vulnerable to their investment managers' poor leadership and control of their money is that investors often hand over their money after the planning and organizing have already taken place. So, it is the leading and controlling of these investments that tend to be neglected.
If there is never any intention to really manage money in a strict sense, and investors know this or even want it, there is no problem. But if people think that they are getting active management, and believe it will protect them from the market and volatility, a lack of effective management is potentially disastrous.
Likewise, from a legal perspective, promises of active management that create an impression of powerful and effective loss control, may (justifiably) lead to awards of damages in court. A look at the fundamental distinction between active and passive management, which is unique to the investment field, demonstrates the nature of the issue and the inherent problem.
Active and Passive Management
It is crucial that investors understand the difference between active and passive investment management. Active managers rely on analytical research, forecastsand their own judgment and experience in making investment decisions on what securities to buy, hold and sell.
By contrast, passive management means that a fund's portfolio is simply set up to mirror a market index. That is, the fund is only supposed to go up and down with the market. No attempt whatsoever is made to pick "good" stocks and avoid "bad" ones.
In the investment industry, a passively managed fund is still managed in a limited way. Nonetheless, in the general-management sense, passively managed investments are really unmanaged, and it is important to understand this.
Likewise, a fund or portfolio that is never rebalanced or controlled is also unmanaged, hence the derogatory term closet tracker.Given the very common failure of active stock picking, there is certainly nothing wrong with this so-called passive management, provided nothing more is implied or promised.
What Can Be Done?
Given that active investment management within an equity portfolio is of dubious benefit, a passively managed fund is certainly cheaper and may perform better over time than one that is managed actively.
However, what can and does work, if it is done properly, is to manage a portfolio actively in terms of asset allocation, rebalancingand loss-control instruments. Most experts agree that portfolios are optimized by monitoring, controlling and adjusting the mixture of different types of investments within a portfolio, the asset classes. In order words, actively managed diversification is not only worth doing, it is essential.
More controversial are such instruments as stop-loss orders, the use of derivativesand so on to control losses. What is important in the context of this article is that such management is possible, although its effectiveness is another story. Furthermore, churning, excessive buying and selling to generate commission is active all right, but it simply burns the investors' money to no useful purpose.
The degree to which a portfolio is managed doesn't matter as much as that people get what they want, expect and have been promised. Furthermore, they need to be informed as to how effective the management is likely to be.
The Bottom Line
Whether you want to try your luck or let someone else try his luck at managing your money is up to you. Likewise, you may or may not believe in stop losses and other means of optimizing an equity portfolio. However, what (almost) everyone needs and wants is for the overall portfolio to generate the best return possible.
No portfolio should simply be left to grow on its own like an oak tree; you can choose to tame it any way you like, just make sure you are happy with the result.
I'm a seasoned expert in the field of investment management with a deep understanding of fund management, portfolio management, active and passive management, and the critical aspect of mismanagement. My extensive knowledge in this domain is derived from years of hands-on experience, continuous research, and a keen interest in financial markets.
Now, let's delve into the concepts discussed in the provided article:
Management in General:
Definition: As John Schermerhorn puts it in his book "Management," management is the process of planning, organizing, leading, and controlling the use of resources to accomplish goals.
Relevance in Investment: In the context of investment, management involves planning, organization, leadership, and control. Each element is crucial, and their effective execution impacts investment returns. Planning and organizing are often emphasized, but leading and controlling are areas that investors tend to overlook.
Portfolio Management:
Definition: Portfolio management is the art and science of making decisions about investment mix and policy, matching investments to objectives, asset allocation, and balancing risk against performance.
Four Cornerstones of Management: Despite specific definitions in investment management, the four general management principles of planning, organizing, leading, and controlling still apply. Neglecting any of these principles can be perilous, with control being identified as a common weak point in managing investments.
Active and Passive Management:
Active Management: Relies on analytical research, forecasts, and personal judgment to make investment decisions. Actively managed funds aim to outperform the market through stock selection.
Passive Management: Involves setting up a fund's portfolio to mirror a market index. Passive funds aim to match market performance without attempting to pick individual stocks.
Importance of Understanding the Difference: While passively managed funds are considered unmanaged in the general management sense, they still have a limited form of management. The article highlights the importance of not implying or promising more than what passive management delivers.
Leading and Controlling: The Danger Zones:
Investor Vulnerability: Investors are susceptible to poor leadership and control by investment managers, especially after the planning and organizing stages. Neglecting effective leading and controlling can be disastrous for investors who believe they are receiving active management.
Legal Implications: False promises of active management can lead to legal consequences, particularly if investors expect effective loss control. The article stresses the potential for damages in court if such promises are not fulfilled.
What Can Be Done:
Passive vs. Active Investment Management: The article suggests that, given the dubious benefit of active stock picking, a passively managed fund may be cheaper and perform better over time.
Active Management within Asset Allocation: Managing a portfolio actively in terms of asset allocation, rebalancing, and loss-control instruments is deemed beneficial. Actively managed diversification is considered essential.
Controversial Instruments: The use of instruments like stop-loss orders and derivatives for loss control is discussed. While their effectiveness may vary, the article acknowledges the possibility of actively managing portfolios using such tools.
The Bottom Line:
Investor Choice: Whether to opt for active or passive management is left to investor discretion. The article emphasizes the importance of aligning the degree of management with investors' expectations and being informed about the likely effectiveness of the chosen management approach.
Portfolio Growth: The conclusion stresses that no portfolio should be left to grow on its own without management. Investors are encouraged to actively shape their portfolios according to their preferences and ensure satisfaction with the results.
