Secret Why Funds Always Invest Their Money in Active Investment

Why Hedge Funds, Pension Funds, Real Estate and Equity Funds Prefers Active Investment?

Since the dawn of the International Stock Markets, investors have been trying to generate returns by investing in individual stocks, commodities or in Government Bonds. In most cases, this is an Active Asset Management that uses the active form of financial investments.[1]

The Active Investment of money is the fundamental idea that one is able to achieve a higher profit than the average market earnings through active responses[2]. A prerequisite, however, is a certain competitive edge compared to the overall market.

The investor must have this knowledge sooner or to a greater extent at their disposal than the market itself. The boundaries for the so-called insider trading, which is generally prohibited are not very clear in this area[3].

Aim of Active Investment

The Aims of Active Investments

The general aim of active investment is to "beat the market" in the long term. This means that you want to achieve the highest possible profit, which is not only above the inflation rate, but also above the expected profit[2].

All actively managed collective investment fund attract customers by conveying them that they are capable of getting best return on active investment. This is also a reason why individual stock, bond or real estate investment funds like to advertise with the personality of the fund manager and his successes.

Looking at the long term success of active investments from a scientific point of view, it quickly becomes clear that Active Fund Manager's term of office is generally too short to be actually used to demonstrate a statistically proven long-term success.

In reality, it is very common that an exceptionally successful fund manager invests mostly in a less successful real estate, bond or equity fund in his next term of office.

The Misconception of Active Investments

However, if the above problems apply to all active investments as financial investment, then why these active investments are so popular?

This is partly because most people in the German-speaking countries still prefer to invest their money in a savings account. They have learned, however, that with this type of investment, little or no interest rates are to be expected and they might even end up losing money in the long run despite historically low inflation rates[4].

Real Estate, Bond or Equity funds are the next step for financial investments with a higher return and a manageable level of risk. Even with this, it must be generally assumed that the money is invested safely by a high level of diversification and the yields are still higher than in a savings account or an overnight deposit account.

Bond funds, real estate or equity funds are the next step for financial investments with a higher return on investment and a manageable level of risk. Even with this, it must be generally assumed that it is a safe investment i.e. the money is invested safely by a high level of diversification and the yields are still higher than in a savings account or an overnight deposit account.

Another reason for the false perception is also the representation of these deposits in the different media. Even the Governments promote the acceptance of actively managed bond, property and equity funds through corresponding programs for private pension schemes[5]. This makes it possible for private investors to be advised by a bank or financial advisor not to spend any money himself.

This system has grown historically and so a few so-called honorary financial advisors can be found in the German-speaking countries.[6] This profession is remunerated by investors contrary to commission consultants, so that they get their money regardless of the eventual investment decision.This type of compensation increases the likelihood that they actually give the customer the best investment solution and not the product with the highest commission for themselves.

The Secret of Hedge Funds, Bond Funds, Real Estate and Equity Funds: Why Only Few Of It Prefer Passive Investment?

If active investments have such a low probability of success, then the question is why only few or no hedge funds, bond funds, real estate or equity funds follows passive investment strategy.

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Again, there are several reasons:

  • Firstly, it is the reputation of an active investment. A man automatically assumes that an active response always promises a higher profit than a passive one.
  • Finally, an assumption that a company can only grow when it makes active decisions to expand and to invest in personnel, equipment and material. We also generalize this experience quite automatically on capital investments[2]. The problem with it is that, either the experience of investors is not enough to actually beat the market in the long term, or this generalization on investments is simply not true.
  • The lack of hedge funds, bond funds, real estate and equity funds with a passive investment profile is the fact that an investor who invests in a collective investment, always hopes that someone else makes the profitable decisions for him.

A fund with a passive investment approach therefore means that entrusted capital is optimally managed, and that is always the problem.

Summary and Conclusion

Active investments have a big problem, because they do not often achieve their own objective; mainly higher returns than dictated by the market. Nevertheless, only the collective investment schemes that pursue an active investment approach enjoy great popularity.

It is assumed that most investors thereby generate a lower return on investment than they need to reach the average earnings of the market. Investments with a passive approach promises greater returns, but is however less accepted.

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