Active vs. Passive Management: Does Alpha Exist?

Active vs. Passive Management: Does Alpha Exist?

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 Active vs. Passive Management: Does Alpha Exist? 2

Active vs. Passive Management: Does Alpha Exist?

An active investment management strategy relies on research analysts and investment

managers to select the most profitable stocks that should be included in a portfolio. Passive

management, on the other hand, involves the use of a specific stock index as a guide on which

securities should be included in an investor’s portfolio. Investors that use a passive investment

strategy believe in market efficiency as reflected by the availability of all current and future

information about securities in the market, which is in line with the efficient market hypothesis

theory (Phan & Zhou, 2014, 61). Investors that use an active investment strategy, on the other

hand, believe that the market changes from time to time, and therefore a portfolio should adapt to

these changes if profitability is to be maintained, which is in line with the adaptive market

hypothesis (Hiremath & Kumari, 2014, 1). Both active and passive investment management

strategies are frequently used in the exchange market and there is no clear consensus on the

effectiveness of each in comparison to the other.

Research Questions

The key research question is whether there are significant differences in the performance

of portfolios managed using active and passive management strategies, as gauged by portfolio

alpha values. The investment alpha basically compares the rate of return of a given portfolio with

a market index or a selected rate of return. The study will also seek to determine whether the

alpha as a measure of performance is ideal for the comparison of the two management strategies.

Research Aims and Objectives

The study aims to identify the difference in the performance of a portfolio managed using

the active management strategy and one managed using the passive management strategy. The

investment alpha recorded by each portfolio will be used as a measure of performance. An

 Active vs. Passive Management: Does Alpha Exist? 3

analysis of the key factors relating to each portfolio management model and how they may

impact on the performance of the portfolio will be conducted.

Hypothesis

The hypothesis to be tested will relate to the difference in financial performance between an

actively managed and a passively managed portfolio. The null and alternative hypotheses have

been identified as follows:

H0: There is no significant difference between the performance of investment portfolios

managed using active and passive management strategies as measured by the portfolio

alpha.

H1: There is a significant difference in the performance of investment portfolios managed

using active and passive management strategies as measured by the portfolio alpha.

Analysis of Research Questions

The research questions identified for the study are specific in terms of the variables that

will be studied. The study will focus on the two investment management strategies and their

effectiveness as shown by the performance of portfolios managed using each. Variables analyzed

by the research question are also measurable, as the investment alpha will be used in the analysis

of portfolio performance. Due to the availability of secondary data in the research area, the key

goals of the study are achievable. The study objectives are also realistic and can be achieved with

available resources and in a timely manner.

An alternative research question that can be used for the study relates to the method used

to measure the performance of the portfolios managed using each of the two methods. An

investment portfolio can either be analyzed in terms of the financial performance recorded in a

given time period, or in terms of the investment risk associated with the portfolio, which is
 Active vs. Passive Management: Does Alpha Exist? 4

measured by the stock beta (Estrada & Vargas, 2015, 78). Alternatively, the key research

question for the study can focus on the investment risk associated with portfolios that are

managed actively and those managed passively.

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References

Estrada, J. & Vargas, v., 2015. Black swans, beta, risk, and return. Journal of Applied Finance,

22(2).

Hiremath, G. & Kumari, J., 2014. Stock returns predictability and the adaptive market hypothesis

in emerging markets: evidence from India. SpringerPlus, 3(428).

Phan, K. & Zhou, J., 2014. Market efficiency in emerging stock markets: A case study of the

Vietnamese stock market. IOSR Journal of Business and Management,, 16(4), pp. 61-73.