IntroductionThe concept of efficiency has become central theme in finance especially as it is used to describe a market in which relevant information is impounded into the prices of financial assets. Simple microeconomic principles indicate that if capital markets are sufficiently competitive, then investors should not expect to make superior profits from their investments (Dimson and Massoud, 1998). According the Efficient Market Hypothesis (EMH) formulated by Fama (1970), an efficient market is one that at any given time, prices fully reflect all available information on a particular stock and/or market. This therefore means that no investor has an advantage in predicting a return on a stock price because no one has access to information not already available to everyone else. But increasingly, investors are using portfolio managers to find mispriced stocks in a bit to make a profit from such (so called active investors), whereas they are some (proponents of the EMH called passive investors) who believe that active management is a total waste of time and effort and are unlikely to justify the expenses they incur as fees to portfolio managers in trying to analyse the prices of stocks (Bodie, 2005). Active portfolio managementActive portfolio managers attempt to achieve returns more than the commensurate risk or outperform the market by either forecasting broad market trends or simply identifying mispriced securities on the market.
The rationale behind active portfolio management strategies is to beat particular benchmarks used to assessing the performance of an investment. The benchmarks among the dozens used by financial analysts include the S& P 500, the Dow Jones Industrial Average, the Russell 2000 Index and the Lehman Brothers Aggregate Bond Index. Many active portfolio managers have their own complex security selection and trading systems used in analysing market trends, the economy and the company-specific factor and methods such as fundamental analysis, technical analysis, quantitative analysis and macroeconomic (factors such as inflation, economic growth, etc) to implement their investment ideas. Active portfolio managers usually use the following strategies: Stock selection: To be up to date with every company’s situation, an active portfolio manager holds few companies in their portfolio for better management purposes.
By analysing all publicly available information about the portfolio, the portfolio manager is able to come up with a stock that is undervalued, since this offers the greatest opportunity for growth above the market averages.
Market timing: Managers at all times try to sell their stocks at peak periods, that is, when prices are up and buy them when prices are down. But it is extremely difficult to find managers who in the long run will get that right. But on the whole, they believe in their skills and experiences to be able to succeed. Bond swapping: Portfolio managers are well aware of the fact that long term bonds are very sensitive to interest rates and capital gains are linked to interest rate changes, portfolio managers attempts to guess periods when interest rates are expected to rise so as to sell long term bond and buy short term bonds and to pursue the opposite action when rate fall for capital gain. Ladder approach: Portfolio managers often buy different securities with different times of maturity just as to keep some fix income at all times.