Active vs. Passive Management: Does Alpha Exist?

Active vs. Passive Management: Does Alpha Exist?

An active investment management strategy relies on research analysts and investment managers to select the most profitable stocks that should be included in a portfolio. Passive management, on the other hand, involves the use of a specific stock index as a guide on which securities should be included in an investor’s portfolio. Investors that use a passive investment strategy believe in market efficiency as reflected by the availability of all current and future information about securities in the market, which is in line with the efficient market hypothesis theory (Phan & Zhou, 2014, 61). Investors that use an active investment strategy, on the other hand, believe that the market changes from time to time, and therefore a portfolio should adapt to these changes if profitability is to be maintained, which is in line with the adaptive market hypothesis (Hiremath & Kumari, 2014, 1).  Both active and passive investment management strategies are frequently used in the exchange market and there is no clear consensus on the effectiveness of each in comparison to the other. 

Research Questions

The key research question is whether there are significant differences in the performance of portfolios managed using active and passive management strategies, as gauged by portfolio alpha values. The investment alpha basically compares the rate of return of a given portfolio with a market index or a selected rate of return. The study will also seek to determine whether the alpha as a measure of performance is ideal for the comparison of the two management strategies.

Research Aims and Objectives

The study aims to identify the difference in the performance of a portfolio managed using the active management strategy and one managed using the passive management strategy. The investment alpha recorded by each portfolio will be used as a measure of performance. An analysis of the key factors relating to each portfolio management model and how they may impact on the performance of the portfolio will be conducted.

Hypothesis

The hypothesis to be tested will relate to the difference in financial performance between an actively managed and a passively managed portfolio. The null and alternative hypotheses have been identified as follows:

H0: There is no significant difference between the performance of investment portfolios managed using active and passive management strategies as measured by the portfolio alpha. 

H1: There is a significant difference in the performance of investment portfolios managed using active and passive management strategies as measured by the portfolio alpha.

Analysis of Research Questions

The research questions identified for the study are specific in terms of the variables that will be studied. The study will focus on the two investment management strategies and their effectiveness as shown by the performance of portfolios managed using each. Variables analyzed by the research question are also measurable, as the investment alpha will be used in the analysis of portfolio performance. Due to the availability of secondary data in the research area, the key goals of the study are achievable. The study objectives are also realistic and can be achieved with available resources and in a timely manner. 

An alternative research question that can be used for the study relates to the method used to measure the performance of the portfolios managed using each of the two methods. An investment portfolio can either be analyzed in terms of the financial performance recorded in a given time period, or in terms of the investment risk associated with the portfolio, which is measured by the stock beta (Estrada & Vargas, 2015, 78). Alternatively, the key research question for the study can focus on the investment risk associated with portfolios that are managed actively and those managed passively.

References

Estrada, J. & Vargas, v., 2015. Black swans, beta, risk, and return. Journal of Applied Finance, 22(2).

Hiremath, G. & Kumari, J., 2014. Stock returns predictability and the adaptive market hypothesis in emerging markets: evidence from India. SpringerPlus, 3(428).

Phan, K. & Zhou, J., 2014. Market efficiency in emerging stock markets: A case study of the Vietnamese stock market. IOSR Journal of Business and Management,, 16(4), pp. 61-73.