Saxo Bank: Making the most of an active management strategy

Business Materials 6 November 2015 14:11 (UTC +04:00)
There are two dominant strategic approaches for financial investments - active management and passive management, Fuad Karimov, Saxo Bank expert, said.
Saxo Bank: Making the most of an active management strategy

Baku, Azerbaijan, Nov. 6


There are two dominant strategic approaches for financial investments - active management and passive management, Fuad Karimov, Saxo Bank expert, said. Both active and passive approaches have their own benefits and challenges, however they both require investors to closely analyse what to buy and to respond strategically to rapidly changing markets.

Choosing what instruments to buy and in what proportions is especially important for passive investors -who are usually following a buy-and-hold approach - because these investors are expected to hold these instruments through all the ups and downs of the market. In fact, deciding what to buy is often the easiest part of a buy-and-hold approach with holding being the most challenging, especially during times of market volatility.

In contrast, an actively managed investment is one where investors are more agile, making judgements about market movements and quickly acting on those judgements by buying or selling parts of the investment portfolio, often across a range of asset classes. Active managers consistently seek investment opportunities that will provide superior returns in the short term.

There are two ways that active managers try to achieve such returns:

• They look to make good asset selections by, for example, identifying financial instruments, such as shares that may be undervalued and investing in them

• They look to take advantage of opportunities based on timing, which means selling an investment when prices are high and buying when prices are low.

In pursuing their objectives, active investors search out information they believe to be valuable, and often develop complex or proprietary selection and trading systems. There are a variety of techniques popularly adopted by active investors in making selection and timing decisions. Technical analysis and fundamental analysis form the foundation of most active investors' trading decisions. This analysis is used to by investors to identify market trends and opportunities to buy overvalued assets (which can be sold for a profit) and undervalued assets (which can be bought cheaply, with a view to making a profit over time).

Technical analysis uses historical data to forecast future movements across different asset classes. There are a number of central beliefs that underlie this analytical technique, which include: market prices generally move in trends that can be tracked over time; price patterns which tend to move cyclically - that is, the same patterns are repeated over time and researching these patterns allow to identify them and thus inform forecast about how prices will move.

Fundamental analysis is a method of assessing the market by analyzing economic, social and political forces that may affect the supply and demand of an asset and thus affect the price of that asset. There are many aspects to this type of analysis including market and industry analysis, looking at financial statements and discounted cash flow analyses.

One instrument which is growing in popularity amongst active investors is Contracts for Difference (CFDs), a derivative product which allow investors to take a position in the market and trade live market price movements without needing to own the underlying asset. CFD trading is predominantly based around short-term trading and investors can realize a gain by forecasting whether a stock, currency, commodity, or index will rise or fall.

The flexibility offered by CFDs is one of their defining characteristics, as it is possible for investors to benefit regardless of whether the market is moving up or down. This means that even when the price of an asset is declining, such as what we have observed in the oil markets this year, investors can "go short" and still find opportunities to benefit from the falling market.

Other key advantages of trading CFDs include the high degree of leverage on offer, with a margin requirement often beginning as low as 2%, meaning less money is required to generate performance than would have been required by acquiring an asset. The attractiveness of CFDs means that they are available not only for stocks, but include commodities, bonds, currencies as well as CFDs based on the major global indexes themselves. It is, however, important to remember that while trading CFDs with leverage does offer the potential for higher returns, it can also mean that losses can be magnified and investors must trade with caution.

Although active investors are seeking short-term profits, they need to think long term and it is wise to have a trading plan as a guide to take action when markets change, whether this means sticking with what they currently own or taking action. If they believe the market might turn downward, active managers can take defensive measures by hedging or increasing their cash positions to reduce the impact on their portfolios.

Regardless of whether taking an active or passive approach, the most important aspect for any investors is taking the necessary steps to educate themselves on the product they are trading to ensure they understand the inherent benefits and risks.