Active Funds (Active Management)

Definition

The term active fund refers to an investment strategy that relies on forecasts, research, and proprietary models when selecting securities to buy or sell.  The objective of active funds is to find securities that are currently undervalued and will outperform the market in the near term.

Explanation

Also known as an actively managed fund, the management team of an active fund believes it is possible to outperform the market over the long term.  This is accomplished through research and the team's judgement.  Individuals that invest in an active fund do not believe in the efficient market hypothesis, which states the current market price of a security fully reflects all of the available information.

The objective of an active fund is to outperform passively managed funds, which buy and sell securities using an indexing strategy.  Since the management team of an active fund is constantly seeking to buy securities they believe are undervalued, and sell securities they believe are overvalued, the fees associated with these funds will reflect higher transaction costs.

While the ability to beat the market is appealing to many investors, a number of studies conclude index funds outperform between 75% and 90% of active funds.  Investors choosing active funds should have relatively high risk tolerance scores, since the fund's management team will be aggressively seeking securities with the potential to provide above-average returns.

Related Terms

fund of funds, asset allocation fund, passive funds, go-go funds