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Understanding Active vs Passive Investing

The document presents a tutorial with questions on capital market efficiency, the justification for professional asset management, and the differences between active and passive investing. It discusses the implications of all investors choosing passive strategies and the efficiency of markets under different investment behaviors. Additionally, it examines the performance of pension funds and mutual funds in relation to benchmarks and the theoretical framework explaining fund managers' returns aligning with benchmarks.

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4 views1 page

Understanding Active vs Passive Investing

The document presents a tutorial with questions on capital market efficiency, the justification for professional asset management, and the differences between active and passive investing. It discusses the implications of all investors choosing passive strategies and the efficiency of markets under different investment behaviors. Additionally, it examines the performance of pension funds and mutual funds in relation to benchmarks and the theoretical framework explaining fund managers' returns aligning with benchmarks.

Uploaded by

ljy925236923
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

Tutorial 1

Question 1: One of the important messages in Topic 1 was that the capital markets are
efficient.
Assume a non-finance person thinks that since the capital markets are efficient all investment
for this person will be directed to a single domestic equity market ETF (Exchange Traded Fund).
Lowest fees with highest diversification imply that this investment will be better than the
average fund performance.
Is there any justification of why investors should use professional asset management services
to help with their investments?

Question 2: What is the difference between active and passive investing and why is a specific
benchmark required when comparing the two investment strategies? Use the table below to
create An active investment (portfolio) that invests in all the 5 stocks (at least 5%) but should
outperform the market (if the analyst’s predictions are correct). The portfolio is currently
invested passively, and each stock is invested in equal amounts.
Stock Current market Price Current Valuation Weighting in a passive portfolio
AXW $12.52 $10.25 20%
NAQ $2.55 $2.75 20%
PLB $42.96 $44.61 20%
UGD $1.75 $0.98 20%
MER $108.65 $106.54 20%

Question 3: We know that in an efficient market, investors are unable to generate returns
consistently above the market, and hence passive investing is suitable. Explain, if markets
would remain efficient if ALL investors invested passively. Now explain if markets would
remain efficient if there was one active investor?

Question 4: Explain the reasons why the textbook uses the example of pension funds to prove
that markets are efficient? Further explain, what were the reasons that pension funds
underperform their benchmark. Is the evidence of mutual fund performance for retail
investors any better than the evidence for pension funds? Why is this the case?

Question 5: Berk (2005) provides a theoretical framework that explains how fund managers’
returns eventually equal benchmark returns. Explain how investors choose fund managers to
invest with and why their returns eventually fall to the returns of the benchmark. Further
explain if this theory explains if markets are efficient or inefficient?

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