Active Portfolio Management Strategy

3368 Words Oct 26th, 2011 14 Pages
Definition: In an active portfolio strategy, a manager uses financial and economic indicators along with various other tools to forecast the market and achieve higher gains than a buy-and-hold (passive) portfolio.
Tracking error is a measure of how closely a portfolio follows the index to which it is benchmarked. The most common measure is the root-mean-square of the difference between the portfolio and index returns.
Many portfolios are managed to a benchmark, normally an index. Some portfolios are expected to replicate, before trading and other costs, the returns of an index exactly (an index fund), while others are expected to 'actively manage' the portfolio by deviating slightly from the index in order to generate active returns or
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Thereafter, the investor would either choose a value based or growth based approach.

Active strategies require major adjustments to portfolios, trading to take advantage of interest rate fluctuations, etc. There are five major active bond portfolio management strategies: 1. Interest rate anticipation 2. Valuation analysis 3. Credit analysis 4. Yield spread analysis 5. bond swaps
In each strategy, the manager hops to outperform the buy-and-hold policy by using acumen, skill, etc.

Interest Rate Anticipation
This is the riskiest strategy because the investor must act on uncertain forecasts of future interest rates. The strategy is designed to preserve capital (lose as little as possible) when interest rates rise (and bond prices drop) and to receive as much capital appreciation as possible when interest rates drop (and bond prices rise).
These objectives can be obtained by altering the maturity or duration of their portfolios. Longer maturity, or longer duration, portfolios will benefit the most from an interest rate decrease and vice versa. Thus, if a manager expects an increase in interest rates, they would structure portfolio to have the lowest possible duration.
The problem faced with this type of strategy is the risk of mis-estimating interest rate movements. It is
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