Active Investment Management

Passive investment, or indexing, is the preferred strategy for those who believe markets are efficient. While administration of passive portfolios requires an efficient organizational structure, there is comparatively less need for knowledge of investments in managing index portfolios. In contrast, active management takes it on faith that markets are not always efficient and that, at least occasionally, bargains are to be found in security markets. Active managers must apply asset valuation and portfolio theory to client portfolios.

Professional management of active investments begins with a contractual relationship between client and portfolio manager. The economic needs of clients must be articulated and their objectives translated into an operational financial plan. For this purpose, the Association of Investment Management and Research (AIMR) designed a framework for financial planning that can be understood by lay clients. Chapter 17 familiarizes you with this framework.

Investments originate with a savings plan that diverts funds from consumption to investment. How much should an individual household save? Taxes and inflation complicate the relationship between how much you save and what you will be able to achieve with your accumulating investment fund. Chapter 18 formulates a comprehensive household savings/investment plan.

Active management attempts to exploit market inefficiency that potentially could arise from market frictions or less-than-fully rational investor behavior. Chapter 19 explores the emerging field of behavioral finance and lays down the fundamentals of behavior that may affect security prices. We also catalogue and explain certain techniques known as technical analysis aimed at uncovering deviations from market efficiency in order to improve investment performance.

Regardless of why prices may not reflect all relevant information, efficient exploitation of security mispricing calls for balancing investment in underpriced securities with diversification. How should this balance be struck? The answer is inseparable from the quandary of how to assess the performance of an active portfolio. Accordingly, Chapter 20 begins with the theory of performance evaluation and proceeds to suggest portfolio management techniques to achieve the goal of superior performance.

Investing across borders is conceptually a simple expansion of portfolio diversification. Yet this pursuit confronts the effects of political risk and uncertain exchange rates on future performance. These issues, unique to international investment, are addressed in Chapter 21.

17 Investors and the Investment Process

18 Taxes, Inflation, and Investment Strategy

19 Behavioral Finance and Technical Analysis

20 Performance Evaluation and Active Portfolio Management

21 International Investing

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