Active vs. Passive Equity Management

Active vs. Passive Equity Management

Investors are rational in that their main objective is wealth maximization, whereby they aim to earn the highest returns while maintaining the lowest levels of risk. The question often arises of whether investors can outperform the stock market since their dream is to live from their investments. The main drawback encountered by investors in answering this question is they fail to acknowledge their limitations (Sharma et al. 20). Although it is possible to outperform the stock market, only a few investors, for instance, Warren Buffet and Peter Lynch, have managed to undertake this uphill task successfully. This is attributed to his extensive operations in the capital market, which clocks decades. More often than not, overperforming the stock market is hindered by several factors, as will be explained by the efficient market hypothesis and random walk theory.

According to the theories presented in the efficient market hypothesis, the individual investor cannot beat the stock market at his stock prices. The efficient market hypothesis is categorized into a weak form, semi-strong form, and strong form (Reilly & Brown 25). The weak form states that all public information regarding the company trading the stock is available to the public. However, the stock is yet to incorporate new information that is yet to be released. This theory argues that the past information regarding the stock does not influence its future prices and, hence, cannot be used to forecast future prices. Therefore, technical analysis is not an effective strategy for determining future stock prices (Reilly & Brown). In this case, the only approach to outperforming the market is through conducting a superior fundamental analysis, which is cumbersome. The semi-strong incorporates the weak form by incorporating past historical stock information. This analysis suggests that new information is quickly incorporated into stock prices. Therefore, an investor would not benefit from having access to this information. The strong form indicates that stock prices always reflect both public and private information (Sharma et al.). Therefore, access to information grants the investor an advantage in the stock market. Notably, one of the techniques for outperforming the stock market is accessing private data before it is available to the public. For instance, if an investor discovers that the company is about to launch an innovation from research and development, he could purchase the stock before this news is released to the public. Once the information becomes public, the stock will appreciate, and the investor will profit from the capital gain. According to the efficient market hypothesis, this occurrence is not possible since stock prices either incorporate the information quickly or always reflect both public and private information.

The random walk suggests that stock prices are unpredictable and follow a random walk. Therefore, technical analysis cannot be employed to predict future share prices. This theory also assumes that the capital market reflects both public and private information efficiently. The reason is that this market efficiently absorbs private information, which is reflected in the stock prices (Reilly & Brown). Moreover, information accessibility is free to all investors. Therefore, none of the investors are privileged to access this data. Lastly, the information is unbiased and correct hence facilitating the fair trade of stocks in the capital market. Another technique of beating the stock market is performing a thorough analysis to predict future stock market prices. Technical analysis is aimed at evaluating a share’s intrinsic value, which influences its future rates. This evaluation is made obsolete by the random walk, which suggests stock prices cannot be predicted since they move in random movement, as illustrated by the Brownian motion.

To gain maximum returns from the investment, the investor should dump the get-rich-quick mentality by investing for the long term. More often than not, stock appreciates considerably over a long period. For instance, Tesla’s share appreciated 12 times over eight years. If an investor had bought this share in 2010 at $1000, his investment would be valued at $12000 in 2018. Similarly, a study indicates that shares trading from 1983 to 2013 had the most returns. On the same note, investors should invest in upcoming ventures that appear promising since their growth would result in a significant increment in their value. The other strategy for maximizing wealth is the indexing of stocks while investing. At the same time, investors should avoid predicting market performance since it has proven fatal through losses incurred by investors who employ this technique.

Even though the theories stated on the impossibility of outperforming the stock market, there lays a possibility as demonstrated by Warren Buffet. The strategy entails stock-picking, whereby investors purchase the best performing stock in the capital market. By doing so, investors would have to study the firms and different industries in identifying these stocks. Through his rigorous study, Buffet studied the insurance industry and invested in stocks that helped him outperform the stock market.

Conclusion

From the analysis, overperforming the stock market is hindered by several factors borrowing from both the efficient market hypothesis and random walk theory.

Works Cited

Reilly, Frank K., and Keith C. Brown. Investment analysis and portfolio management. Cengage Learning, 2011.

Sharma, Bina, et al. “Dodd-Frank Act, Credit Rating Agencies and Corporate Financing and Investment Decisions.” Credit Rating Agencies and Corporate Financing and Investment Decisions (November 17, 2019) (2019).

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Description: Read Chapter 16 – Equity Portfolio Management Strategies. You will find many of the active and passive strategies within this chapter. Research and analyze an individual investor’s ability to beat the Stock Market. The stock market can be defined by any index, such as the S&P 500 Index or Dow Jones Industrial Index. Beating the market means that the stocks in your portfolio outperformed the stock market, as defined above, on a risk-adjusted basis.

Active vs. Passive Equity Management

Suggested Research Topics: You may use these references below, but put them in your own words. These are not required topics, but they may give you a good base on which to start your research.

Answer the following questions: 1. Can an individual investor beat the stock market? If so, how? If not, why? Many practitioners and academics are divided on this issue 2. If so, what must this individual do in order to beat or outperform the stock market? 3. If not, what should an investor do?

Topics to Research:
• Efficient Market Hypothesis (Pros and Cons) • Value vs. Growth • Tax implications and transaction costs of trading vs. buy and hold (buy and hold is not necessarily ‘passive management’) • Random Walk Theory • Active vs Passive Investment Management Research Paper Guidelines 1. Stick to your topic. Don’t stray into too many examples or irrelevant facts. 2. Minimum 5 pages, double spaced, Maximum 10 pages. You may use graphs and charts, but make sure the content is covered in the writing. 3. Source: You can use any source, including the internet, to research, but you need to source. Use footnotes, so I know exactly where you got the information.