The Theory and Practice of Investment Management: Asset Allocation, Valuation, Portfolio Construction, and Strategies, Second Edition

ACTIVE INVESTING

In contrast with passive investing, active investing makes sense when a moderate to low degree of capital market efficiency is present in the financial markets (or areas thereof). This happens when the active investor has (1) better information than most other investors (namely, the “consensus” investors), and/or (2) the investor has a more productive way of looking at a given information set to generate active rewards.

In general, active strategies can be classified as following either a top-down approach or a bottom-up approach. We discuss each approach in this section.

Top-Down Approaches to Active Investing

Before delving into the “top-down” approach to investing, it should be noted that those who actually use portfolio analysis to select portfolios do so in one of two major ways: top-down approach and all-at-once approach.

In the top-down approach, a “top-down” portfolio analysis is performed at the asset class level. Then, the asset class allocation is implemented either passively or actively. If implemented actively, this can be done quantitatively or informally. If done quantitatively, then the asset class index becomes the benchmark for the manager with this mandate. In this approach to portfolio analysis, expected returns for asset classes can be based on macroeconomic models or other considerations. This was demonstrated in Chapter 3 where we discussed Markowitz portfolio selection. In the “all-at-once” approach to portfolio analysis, means, ...