Actively managed funds are funds that try to outperform their benchmarks (usually the relevant indexes) through the implementation of a sophisticated investment strategy. In contrast, passive (index) funds match the performance of a particular stock market index such as the S&P 500 index in the United States or the EuroSTOXX 50 in Europe.
Trading strategies of actively managed funds try to generate excess returns or lower investment risk. Trading strategies are usually built on technical or fundamental analysis of individual firms or sectors, anticipation of macroeconomic trends, or the application of (proprietary) models of the financial market.
In turn, actively managed funds usually charge higher fees from investors compared to their passive index counterparts. In addition to that, more trading expenses are incurred because the portfolio composition is changed more frequently. On the other hand, trading expenses are usually rather low for index funds because the composition of stock market indices is stable over time.
In order to evaluate the performance of actively managed funds, returns must be put into relation to risk. Common measures are Jensen’s alpha, Treynor ratio, or Sharpe ratio. Academic research has shown mixed results concerning the success of actively managed funds: On average actively managed funds tend to underperform their benchmarks since expenses and fees frequently reduce performance to a significant extent as found e.g. by Carhart (1997).
Active management is primary suited for ineficient markets where fund managers may create value by investing in targets for which they have informational advantage. This point of view is substantiated e.g. by Kacperczyk et al. (2005) who document that concentrated funds perform better than broadly diversified portfolios.