Difference between Active Investment Strategies and Passive Investment Strategies

Active Investment Strategies	Passive Investment Strategies
Definition
Active investment strategies involve managed investment funds on which professional fund managers or research teams, who make all the investment decisions, e.g., companies to invest in or when to buy and sell different assets, on someone’s behalf. They have widespread network that helps them research different markets, sectors and help in investment decisions.	Passive investment strategies involve investment funds following a certain market, and are less expensive compared to active investment strategies. The funds are basically computerized through which one may buy all or majority of the assets in a particular market whose outcome reflects market performance
Objective
In active investment strategies managers try to choose stocks, bonds, mutual funds that seemed of monetary value and particular time of when to move in or out of markets, and basically bet on the future direction of securities and markets with options, futures, and other derivatives. Their objective is to make a profit, without accepting average market returns.	Like active investors, objective of passive investment strategies is also precisely want to make a profit, but with the acceptance of the average returns various asset classes produce. In Passive investment strategies markets are divided into asset classes which make up a company’s portfolio.
Managed and Indexed Funds
Managed Funds are involved in active investment strategies, managed by an individual manager, co-managers, or a team of managers. They have long-term performance records that are above their rivals.	The index funds are used in passive investment strategies which are passively managed, meaning that their portfolios reflect the market index. The money involved in an index fund is inevitably invested uniformly into individual stocks or bonds according to the percentage of market index present.
Risk Factor
Managers that choose active management strategies attempt to select securities that will perform exceptionally well in the market and, so, risk betting on relatively attractive but few securities. If an active manager is wronged, they may have to bear loss.	In Passive investment strategies diversified portfolios are made which consist of number of securities from different investment categories which have been checked and selected by thorough research and have predictable risks and returns.  These securities may not provide exceptional returns but also never produce exceptional losses.
Performance
Performances of active investment strategies depend on selected handful of extremely well known money managers with exceptional past performance of active management. Yet, the odds of making the right decisions are less likely, and the fact is possible that the results achieved by those active managers in the past may be due to sheer luck.	Research shows that portfolio performance differs from one money manager to another primarily due to the asset class (es) they choose.  Markets, not managers, produce returns.
Institutions Support Wall Street firms, banks, insurance companies, and other groups support active investment strategies. Intention When an investor, who adopts active strategy, invests in securities, his intention is usually earning short term benefits. They are short term profit seekers. Monitoring and management of portfolios Active investors monitor their portfolios of investments on ongoing/ day to day basis. They check price movements of their securities very frequently, generally many times a day. Cost of fund management Active fund managers undertake tiresome research in the market sectors for assessment of prospects prior to making a decision about investment. Resultantly, a fund manager charges more Tools used in Analysis Active fund managers use the tools of technical and quantitative analysis, e.g ratio analyses and various mathematical measures, because they are concerned with detecting and exploiting the short term fluctuation in a security. Risk and Return Active investment strategy has the potential for higher returns and it entails higher risk as compared to passive strategy.	Passive investment strategies are supported by the nation's universities and privately funded research centers. The intention behind purchasing of securities by passive investor is usually the pursuit of long term appreciation. Passive investment strategy involves limited frequent buying and selling. If investing via a fund manager, the cost of passive fund management is lower, because the strategy is simply tracking a market, so lesser compensation is charged. Passive fund manager usually relies on fundamental analysis of the company in which security they are intending to invest. This includes the long term strategy of the company, the product quality. The study is done to evaluate long term potential of any investment. The return of passive investors is tied to the overall market and it is relatively less risky option as compared to active investment.

10 Successful Reconstruction Strategies

1.Downsizing

Call it downsizing, layoff, rightsizing or smart sizing; in essence, it is all one and the same thing. This restructuring strategy is about reducing the manpower to keep employee costs under control.

Example:

Take the case of auto-giant General Motors, which in 1991 decided to shut down 21 plants and lay off 74,000 employees to counter its losses.

Example:

 IBM, which had never laid off staff ever since its incorporation, but had to layoff 85,000 employees to stay in business. This type of restructuring is tough to manage and is mostly adopted to overcome adverse situations. Downsizing is not always a result of business losses; it may be needed even in cases of takeovers, acquisitions and mergers, where duplicity of the staff propels this form of organizational restructuring.

2. Verticalization

This is the latest in restructuring trend, wherein an organization restructures itself to offer tailored products and services to cater to the requirements of a specific industry.

Example:

In 2002, HCL verticalized its operations to meet the specific demands of five different industries: retail, media and telecom, manufacturing, finance and life sciences. This type of restructuring opens up avenues for specialization.

3. Outsourcing

Today’s businesses prefer to outsource some of their processes to other firms. There are two ways outsourcing benefits a business; first, it helps in reducing costs and second, it allows the business to concentrate on its core business and leave the remaining tasks to outsourcing firms.

Whenever a business plans to outsource one of its processes, it will cause some major restructuring and reshuffling within the company. Downsizing is common when a business outsources its processes.

Example:

 For instance, Nokia plans to layoff 4000 of its employees by the year end 2012, as it will be outsourcing the production of its Symbian operating system

4. De-layering

De-layering involves breaking down the classical pyramid setup into a flat organization. The main objective of this type of restructuring is to thin out the top layer of unproductive and highly paid ‘white collar’ staff. General Electric has reduced the number of management levels from ten to four in some of its work facilities in order to improve overall productivity.

5. Starburst

This restructuring strategy involves breaking a company into smaller independent business units for increasing flexibility and productivity. This may be done either to dissect the business into manageable chunks or when the business wants to diversify and foray into unrelated areas.

Example:

One of the latest examples of this strategy is Pfizer’s decision to spin off four non-pharmaceutical firms this year.

Starbursting may also be used for expansion of the existing business such as when a business decides to spin off subsidiaries to handle business in different geographic areas.

6. Virtualization

 This strategy involves pushing employees outside the office to places where they are more needed like at the client’s site. It also involves upgrading to technology, which allows unmanned virtual offices to be set up.

Example

 The ATMs offered by banks are their virtual units.

7. Business Process Reengineering

This type of restructuring is carried out for making operational improvements. It begins with identifying how things are being done currently and then it moves on to re-engineering the tasks to improve productivity.

Business process re-engineering usually results in changing roles. While at times BPR may lead to layoffs, it can also create new employment opportunities.

Example

When Ford Motor was trying to reduce its cost, it found that the process at its accounts payable department needed to be re-engineered. The reengineering helped in simplifying the controls and maintaining the financial information more accurately, that too after laying off 75 percent of the staff from the accounts payable department.

8. Strategies, which are based on realistic goals:

Successful strategies are the one, which is based on realistic goals. Such a strategy that focuses on the realistic goals and fulfill the realistic target

9. strategies, which are based on right people, involved

Such, a strategy, which involves the right people. This leads to the success of the strategy. Such h a strategy rarely leads to unsuccessful path

10. Strategies, which are based in the sufficient data:

A strategy, which is based on sufficient data, and all the required information and data, is being taken in the analysis while making up the strategy, such a strategy is said to be a successful strategy

Effect on Economy due to changes in Exchange Rates

Exchange rate changes occur due to a number of micro and macro economic factors. These are the result of currency fluctuations and in turn affect the economies of countries. The fluctuations in exchange rates due to currency fluctuation are a natural result and are true for the economies of most countries. A lot of the factors that affect the exchange rates of any currency have been mentioned above. The currencies keep on fluctuating in a continuous pattern, from one moment to the next one.

These changes in the exchange rates of a country that are a result of various micro and macro economic factors in turn affect the economy of that nation. People generally do not have any close idea of the effects of exchange rate changes on the economy because they deal mostly in the domestic currency and make payments in it as well. People believe that strong domestic country is a good thing which sometimes proves to be false as a continuously strong domestic currency can also prove to be a drag on the nation since the home country’s products will be much more expensive in the international markets and, hence, would be less competitive in place of the products of those countries whose currencies are not as strong. As a result, the home country might not have very good exports. But, as the international market items would be less expensive so they would be imported more. This would result in a negative trade balance.

On the other hand, if the domestic currency is weak in comparison to other currencies, then it would also pose a lot of problems for the people of that nation as it would make international travel more expensive and the cost of imported goods would also increase. If the cost of imported goods higher than its exports, it could also result in a negative trade balance.

Domestic currency’s value is a very important instrument in the setting up of the monetary policy and in all the central bank actions as well. it also effects the interest rates and many other important parts of the nation’s economy.

An increase in the exchange rate of a country’s currency would increase the purchasing power of the people of that country as they would be able to buy more foreign goods than before. For example, a US citizen can purchase a lot more clothes at cheaper rates from Pakistan than he or she can from their own country because for them Pakistani goods are much cheaper . Whereas, a decrease in the exchange rates of a country’s currency would decrease its people’s purchasing power as it would result in them being able to buy lesser international goods than before. A Pakistani purchasing a commodity from US would have to pay a lot more now than they had to in the 1990s because the exchange rates of Pakistani are much lower now than before as compared to US dollar. Higher exchange rates of a country would also mean higher standard of living of the people of that country. For example, a Pakistani living in the US would have to spend more money in acquiring goods and services there than here because of a high difference in currency values. 

Fixed Versus Floating Exchange rate regimes

Fixed exchange rate regime

·         Operations in the forex market are passive in nature.

·         Exchange rates are determined by governments.

·         The set price of the home currency will be determined by comparing it with a major world currency.

·         The central bank buys and sells its own currency to maintain an exchange rate.

Example:

The Thai baht was pegged to the US Dollar. People used to consider it a prized currency investment. After the adverse capital market events of 1996 to 1997, the currency depreciated and Thai baht plunged rapidly because the government was not able to defend its currency by using the limited peg reserves nor was it willing. Later, in 2007, the Thai government had to resort to floating its currency along with accepting a bailout from IMF. The baht had fallen by about 40 percent during the time between July 1997 and October 1997.

Saudi Arabia follows a fixed currency regime. The currency of Saudi Arabia is Saudi Riyal which was pegged against the US Dollar and it was determined by the Saudi Arabian Monetary Agency. During the time between 1960 and 1975, the Saudi government made several changes in their currency rates in order to maintain the gold rates. But in march 1975, an effective rate was introduced and it was linked to SDR and the exchange rate of Saudi Riyal was pegged to SDR at 1 SDR equaling SRL 4.28255. Due to this, the currency was allowed to be floated partially at a margin of 2.25 percent, resulting in the appreciation of the currency.

Floating Exchange rate regime

·         Operations in the forex market are active in nature.

·         Exchange rates are determined by demand and supple factors.

·         Any difference in the demand or supply will automatically change the prices.

·         It is constantly changing.

·         The central bank may also sometimes intervene to stabilize a currency or to avoid inflation.

Example,

Brazil follows a floating exchange rate regime. This regime was adopted by the country in 1990. But this regime was subjected to an adjustable band from the time between 1995 to 1999 to control money creation. As before whenever the inflation in the country got out of hand, it issued a new currency with a different name. Still, during this time period, there was still high inflation. In 1999, Brazil faced major currency crisis and its currency was set to float independently from then on.

The currency of South Korea is Won (W). It was pegged initially to the US Dollar. But, in February 1980, the Won’s fixed pegging to US Dollar was dismissed and the currency was then floated by the country and a floating effective rate implemented. Thailand’s decision to float baht on 2^nd July, 1997 result in depreciation in the value of Won and this forced the government to defend its currency. It did so by first widening the band from 2.25 percent to 10 percent and then abandoning it entirely and floating the currency on 12^th December.

Impact of Exchange rate on economy and individuals

Impact of Exchange rate on economy and individuals

The market based exchange rate varies with respect to either of its components; currency raises its worth when the inclination of demand is higher than supply and loses its worth in reverse condition whereas the need of money is there, the preferred mean of wealth shifted to other currency or any other form, in case of transactions the demand for money has speculative increase which is strongly associated to GDP, business environment the employment level because the unfavorable condition of a region shrink the spending level  and eventually central bank  need to change the trend to adjust its need of money for business transactions which compels the bank to adjust its rate of interest if it is already high enough, sometimes it’s been speculated demand to hold the currency stable and it could be done with an artificial downward on currency, in short for taking profit the speculator could buy the currency back when it depreciates.

The worth of currency varies with its supply and demand same thing happens for purchase of imported products when the currency is strong like US-dollar, similarly when interest rate is upward it tend the people to invest in other securities, eventually this lead to trade deficit when dollar in a strong position whereas an opposite impact on exports. The worth of currency has a vivid impact on imports and exports and ultimately affects the economy, individual’s life in numerous ways. This rise and fall of the worth of currency is the reaction of the forces i.e. supply and demand which could be observed via foreign exchange rate in a particular region. The sour worth of currency diminish the people’s spending and business sentiments which is not possible in a boomed economy which is a pedestal of a strong currency and provide the governments intervene so that the other factors like inflation, interest rates, employment, governmental initiatives etc.

Currency Regimes

Fixed Exchange rate system:

According to the fixed exchange rate system the government is held responsible to maintain a fixed exchange rate for its domestic currency, under this regime the government announces both the par value and the band of exchange rates within which the exchange rate varies, the exchange rate announced by the government is known as the parity rate and in order to prevent the exchange rate from appreciation the government buys foreign currency in exchange for domestic currency this would result in an increase in the supply of the domestic currency on the other hand for the avoidance of depreciation of the domestic currency the government will buy the domestic currency using the foreign currency.

Real world example:

The world been pledged

It was a time when currency’s worth and exchange rate was associated with the gold i.e. 1870 to 1914, the gold standard was a provision for infinite capital mobility, trade and currency stability and it was vanished during world-war-1, so by the end of world-war-2, a deliberated rules were established for governing the international exchange rate and the result was IMF to propagate and maintain the monetary stability all over the globe.

Flexible Exchange rate regime:

According to the flexible exchange rate system the exchange rate is established through the forces of demand and supply for a currency vis-à-vis another currency, every nation in order to achieve its economic objectives chooses an exchange rate system.

Examples of countries following flexible exchange rate system are as follows:

1)      The United States

2)      The United Kingdom

3)      Canada, Japan,

4)      New Zealand and

5)      Australia

These countries permit their currencies to float independently in the foreign exchange market and it is important to note that the exchange rate of these currencies is determined by the market forces. Under the flexible exchange rate system both the monetary and fiscal policies are not supposed to be subordinated to the need of defending the exchange rate and the supporting polices can be directed by the anchors like target inflation rate and target growth rate.

Revaluation of currency:

Under the fixed exchange rate system the increase in the value of currency relative to another currency is known as Revaluation of currency

Example:

During the period of 1970’s to 1990’s Turkey experienced a severe depreciation because of its hyperinflation but with the revaluation of Lira in 2005 made this currency the world’s least valued currency.

Depreciation of Currency:

Under the floating exchange rate system a fall in the value of currency relative to another is known as Depreciation of Currency

Example:

§  In 1997, Thailand’s “Baht” got depreciated because of its weak financial sectors and decrease in the quality of investment and most importantly the poor banking supervision led many of the foreign investors to pull out of the country.

§  During the period of 2006-2007 the USD depreciated against most currencies, the major reasons behind this depreciation were the narrow interest rate differentials, the subprime crisis and the robust growth in the EURO area.

Appreciation of Currency:

Under the floating exchange rate system an increase in the value of currency relative to another is known as the Appreciation of Currency

Example:

In 2008 the USD appreciated against most of the currencies, one of them was Indian Rupees (INR), on 24^th October, 2008 INR plunged to a fresh all-time low of 50.11 against the USD, the main reason behind this was the downward trend in the Indian Stock Market which resultantly enforced the foreign institutional investors to sell their Indian stocks by this they would be able to realize their money in USD, the purchase of USD at higher level resulted in the sharp depreciation of INR against the USD. 

EFFICIENT MARKET THEORY

EFFICIENT MARKET THEORY

Eugene Fama developed EMH theory forty years ago in three forms that are weak , strong and semi-strong .there were two important criteria of EMH theory.

·         Availability of new information can only cause change in the prices of shares

·         The current prices of the shares shows all the information or data used by the market

                                         

                                              EMH a bad science

Arguments against EMH theory

·         Even after the global recession many companies, markets and governments are in favor to promote the semi –strong hypothesis. Soon after the 1985 crash a academic community started a camp of awareness that the EMH is a bad science in whatever form it is.

·         First reason for calling it a bad science is that EMH follows those assumptions that have no empirical evidence that these assumptions are 100% true.

·         Financial models are based on efficiency, rationality and EMH is far from real world applicability therefore EMH increases its chance of beng bad science

·         EMH doesn’t develop alternative financial modes for the guidance of corporate sector and its management

·         EMH doesn’t provide models to guide the corporate management that how they can set the shareholder wealth via equity prices.

·         According to behavioral theorists markets has a sense to memorize and view the society as a non-linier

·         The view of EMH is based on assumption  that anything  can be maximize with market incoherence and speculative thinking which is not true.

·         Financial models are bedrock for the modern finance, unfortunately EMH failed to provide such models to the corporate sector

Ø  Longer-run resource value misalignments in all likelihood speak to the most genuine indication of the disappointment of the productive business speculation. Most tests of the theory don't give prove, somehow, about the likelihood of such misalignments. Different sorts of confirmation, then again, unequivocally propose that such misalignments exist, at minimum on occasion. In the stock market, the evaluating of shut end stores is difficult to see as the result of a proficient business sector.

The 1987 stock market crash, and the uncommon run-up in US stock costs over the 1990s are both difficult to comprehend with the exception of regarding markets which have moved some separation away from levels reliable with basics. The failure of models focused around financial basics to clarify more than a little portion of the year-to-year developments in coasting trade rates has undermined trust in the limit of the effective business speculation to give a persuading portrayal of this business sector. This certainty has been further23 disintegrated by the odd conduct of the US dollar in the 1980s and the Yen in the 1990s. (Meredith Beechey)

Arguments in favor of EMH

According to M.A. Skrutkowski, Lund University the ramifications of the Data Hypothesis are broad to the point, that it is conceivable to harbor a considerable measure of apparently bizarre value conduct under its top." We have no real way to characterize "data" other than that its what moves costs. Then again, the EMH did not result in the money related emergency. It was not awful science however the terrible deeds that are the certain result of a liberated free enterprise belief system that the EMH is utilized to legitimize. (M.A. Skrutkowski).

·         Supporters of the EMH theory can contend that numerous appearing infringement of the theory are rather illustrations of the 'awful model' issue. Under this elucidation, unsurprising abundance returns speak to remuneration for hazard, which is inaccurately measured by the benefit valuing model being utilized. While this is an intelligent probability, it probably applies with logically less constrain the longer the infringement stay unexplained utilizing models focused around the proficient market speculation. (Meredith Beechey)

References

M.A. Skrutkowski, L. U. (n.d.). Why the Financial Crisis Was Caused by Bad Science . Kinky Demand and Tautologies .

Meredith Beechey, D. G. (n.d.). THE EFFICIENT MARKET HYPOTHESIS:.

Factors affecting Exchange Rate

Monitory Policy

If the Central Banks thinks that any sort of intervention in the foreign exchange market would remain consistent with the monitory policy of the government, it will take part in the trading of foreign exchange and in the influencing of the exchange rates. Generally, a central bank does this by the buying and selling of the home currency in order to stabilize it to a required level.

For example, when 1987 was at an end, the US Dollar was under the effect of major continuous depreciation and in order to stabilize the value of US Dollar, the finance ministers of the country released a joint statement  that they would be intervening in the forex market.

Political Situation

Political situation of a country is very effective in influencing that country’s exchange rates. Any political tension will result in instability of the exchange rates. If there is political instability in a country, then there will be irregular inflow or outflow of that country’s currency. Such irregular behavior in a country’s currency purchases causes fluctuations in its exchange rates. And if the political situation of any country is stable then it will experience stable exchange rates.

For example, during the Kosovo war for three consecutive months the Euro fell by 10 perecnt against the US Dollar because of downward pressure of the war.

Balance of Payments

Balance of payments of a country reflects all its economic dealings of that country with the rest of the world. Balance of payments of a country also causes fluctuations in the exchange rates. It also affects the demand and supply of that country’s currency. Any sort of economic activity that results in an inflow of foreign investment will result in foreign revenue. Only the home currency of a country is allowed to be circulated in it so the foreign currency will have to be converted to domestic currency first which creates a supply of those foreign currencies in the foreign exchange market. Whereas, all those economic activities that result in an outflow of capital would result in domestic currency being converted to foreign currency and create a supply of domestic currency in the forex market. Both of these and other imbalances in the balance of payments cause fluctuations in the foreign exchange markets.

For example, one of the reasons of dollar depreciation in the United States in 2006-2007 was a current account deficit in the country of 7 percent.

Interest Rates

If one country’s interest rates go higher or lower in comparison to another country’s currency, then the country with the higher interest rates will be bought in order to gain high returns. Since this will create a demand for that currency, then its value will increase as compared to other currencies.

For example, one of the reasons for the fall in the value of UK Pound Sterling in 2007 to 2009 was a 0.5 percent drop in the interest rates.

Market Judgment

There is no logical or set pattern on which the foreign exchange market works. There are certain irrational and intangible factors at work as well such as emotions, rash behavior of the people, analysis, judgments, comprehensions etc. It is the job of market operators to interpret the data and make judgments as to how the market will behave based on those interpretations and these will also be reflected on the prices. If the actual market actions deviate from the judgments and reports, then there are seen fluctuations in the exchange market.

For example, the market judged ahead of time the drop in the value of Canadian dollar during the time period of 1997 to 1999.

Speculation

Speculation of the market rates is also another factor that affects the exchange rates. Mostly, the transactions are speculative trading while in reality the percentage of those transactions that are linked to international trades is lower. Speculation sometimes forces a certain action like it may result in a frenzy buying of one currency which will end up fulfilling the prediction. On the other hand, if a market speculates a certain drop in the value of some currency, then it might also result in people selling the currency and end up force proving the speculation. 

For example, from 1960s to 1970s, there were many scandals in the US including the Vietnam War and Watergate scandal. The Speculators predicted a drop in the value of US dollar and it did drop as well.

Inflation

Countries that have low inflation rates get their currency values appreciated. If inflation is low in one country, then it means that the prices of the goods of that country will be lower as compared to the same kind of goods of other countries. This kind of competition will result in people willing to purchase that currency in order to purchase goods from there and this will create a demand for that currency in the forex markets.

For example, in 2008 there was extremely high inflation in Zimbabwe due to which one US Dollar became equal to 600,000,000,000,000,000 Zimabwean Dollars.

Change in competitiveness

If the goods of one country start competing with other international goods of the same kind, then it will also create a demand for that currency in the forex market as people will have to purchase that currency in order to purchase those goods and its exchange rates will rise.

For example, when Japanese Yen increased in value then its people could afford more of the international goods. 

Relative strength of other currencies

If the strength of some major currency is in doubt, then people will start purchasing other currencies that they deem safer and this will create a demand for it in the forex market, pushing its exchange rates higher.

For example, after 2007 when Benzair Bhutto was assassinated in Pakistan, people were in doubt of the strength of the currency and started selling it which resulted in a decline in its value in the forex market.

Government Debt

The value of a debt that a government is under also influences the exchange rates of that currency. For example, if there is a fear of the government defaulting on its debt then investors will start selling that currency which will cause its exchange rates to fall.

For example, Iceland had major debt problems in 2008 due to which the currency of the country saw a very rapid fall in its value.

Government Intervention

Governments sometime intervene in the foreign exchange markets to keep the values of their currencies at a set level. If they want their currencies to be appreciated then they will purchase their own currencies at the exchange market, thus keeping the currency value high.

For example, to make their products remain competitive in the international market, the Chinese government intervened to have Chinese Yuan devalued in comparison of US Dollar.

Economic growth / recession

In case of recession in the economy, the interest rates of a country fall which is why its currency gets depreciated. On the other hand, when there is growth in the economy, the interest rates go up, causing an appreciation in the value of that currency.

For example, when there was severe recession in the UK, the UK Pound Ssterling fell nearly 20 percent in its value in the international market.

Trade Balance

The trade balance or balance of trade of a country is the value that we get after subtracting its total imports from its total exports. The country has favorable balance of trade if the resultant is positive and unfavorable if it is negative. It impacts the supply and demand of the currency of the country. In case of favorable balance of trade, demand for its currency increases, whereas, it falls down in the other case

Public Debt

Governments usually engage in the activity of deficit financing at a large scale in order to make payments for capital or public projects. Even though such activities are good for the domestic economy, yet such large public debts and public deficits give a poor impression to foreign investors. Increase in money supply and large debts also result in an inflationary situation in the economy due to which currency value gets lowered.