Active management in mutual funds: advantages in the current market scenario

After 2023 closed out with a rally in stocks and bonds to see profitability return to the market, the path forward for investors in 2024 is an optimistic one. It looks like the macroeconomic environment could also follow suit. Mapfre Economics’ predictions for this year suggest a global economic outlook with a level of growth that, while moderate, could reach 2.3% with inflation continuing its downward trend and monetary policy tending towards a laxer approach.

On balance, the expectations for this year paint a picture where recession could be avoided and risks are more balanced and controlled by central banks.

Although this scenario is positive, it is not free of challenges. Volatility has taken hold in financial markets, and geopolitical risks remain at the forefront. The war in Ukraine, the armed conflict in the Middle East, the attacks in the Red Sea—there are a number of points of tension evolving that could impact the course of the economy and of markets. Add to this the uncertainty from the many dates on the 2024 election calendar, which will bring a good part of the world’s population to voting booths. The spotlight is on the voting for the European Parliament in June but, above all else, on the US presidential elections in November.

In a global financial landscape characterized by volatility in all asset classes and uncertainty, active management in mutual funds has emerged as an essential strategy for weathering the market. This approach, in contrast with passive or index fund management, entails careful selection of assets and continuous re-assessment of portfolios.

We will go over below how active management in mutual funds can offer significant benefits in the current context of the market.

Asset selection

Active management of mutual funds involves fund managers continuously selecting and monitoring assets to outperform the market or a benchmark index. That is why exhaustive research is a fundamental cornerstone of active management. These teams dedicate significant resources to analyzing companies, sectors, and global economic trends. This is a unique process where the goal is to gain an in-depth understanding of the business model and financial situation of a company or country. An exhaustive analysis is done on factors like solvency and environmental, social, and corporate governance (ESG) criteria.

This dynamic approach can identify undervalued assets with potential to “jump” on them, while also helping to avoid assets with less promising outlooks. It is a particularly valuable philosophy at a time like now when we cannot rely on a clear future direction in interest rates and tech disruptions and changes in consumer behavior redefine industries.

For their part, investors delegate all the transactions to professionals. So the only thing they need to do is seek out guidance on the fund that best suits their needs.

Adaptability and agility

Active management provides a high level of flexibility in asset allocation and strategy. Although every fund will have a specific classification—equities, bonds, mixed, thematic, and geographic, among others—management teams can recalibrate exposure levels to the range of asset classes, their weights in the portfolio, and their duration, according to their outlook on the market and economic cycles. This ability to make moves is crucial in an environment where quick changes can swiftly make losers into winners and vice versa. For example, when there are signs of a recession, an active manager can take a more defensive approach that increases exposure to high-quality bonds and reduces investment in stocks.

In a highly variable environment like what we are seeing today, active management can quickly adapt to changes in the market, adjusting the portfolio in response to economic, political, and social developments.

Potential to outperform

Active management primarily aims to provide returns that are higher than the market or the benchmark, while passive management simply tracks the performance of an index. The flexibility of active management means we can take advantage of opportunities that passive management would miss by joining in on market trends or identifying them before others, in addition to taking advantage of inefficiencies in the market and generating returns.

Although active management can mean higher costs when compared with passive strategies, the potential for higher returns justifies this investment for many investors. For investors, it is important to always bear in mind that past performance is no guarantee of future results. Moreover, before selecting a fund, it is best to carefully assess the managers, considering their record, their investment strategy, and their ability to generate alpha (the excess returns above the market when adjusted for risk).

Risk management

In addition to aiming to outperform the market, active management proactively prioritizes risk mitigation to protect shareholders’ capital. In general, managers are focused on anticipating changes in the economic cycle to correctly position their portfolios and be prepared. They also use advanced risk management techniques—such as diversification, hedging, and adjusting the portfolio’s duration—which help to react when facing unexpected events.

During times of great uncertainty, underweighting vulnerable regions or sectors can make all the difference, making an active approach decisive in preserving the investment’s value and avoiding significant losses or offsetting them in the long run.