A Piece of the Pie: Approaches to Active Stock Management

Thoughtware Alert Published: Oct 20, 2021
A Piece of the Pie: Approaches to Active Stock Management TW

One of the first decisions to make when investing in stocks is to choose an active or passive approach. The passive approach is most often implemented using a mutual fund or exchange-traded fund (ETF) that replicates a broad-based market index. By contrast, the traditional actively managed stock portfolio often holds a smaller but diversified group of individual stocks, either directly or through a mutual fund. The active portfolio—often 20 to 40 companies—wins or loses based on the selection of stocks out of a pool of thousands of companies. However, today there are other ways to actively manage a stock portfolio, offering the ability to customize and manage the amount of risk taken. Here are two alternative methods to employ active management using broad-based, highly diversified portfolios.

The first method is to overweight or underweight segments of the market using indexed ETFs. This can be done across market capitalization, i.e., size of the company, style characteristics, i.e., value versus growth, and/or economic sectors. Think of the stock market as a pie that can be sliced by these various metrics. For example, small-cap stocks are roughly 15 percent of the market pie, while the technology sector is approximately 27 percent. An investor can actively manage a stock portfolio by simply adjusting the size of these slices. One could reduce technology to 20 percent of the pie or increase small-cap to 25 percent. The magnitude of outperformance (or underperformance) to the underlying benchmark will then depend on the degree of change in the allocation. By using index ETFs, an investor can overlay active management while removing the stock-specific risk that is present in a concentrated portfolio. This approach to active management also keeps expenses low. 

A second technique for active stock management is to use “smart beta” strategies to emphasize certain investment factors. These strategies start with a broad market index and adjust it using a “rules-based” approach. This can be as simple as weighting all the stocks in the index equally or removing parts of the index based on criteria such as profitability or volatility. The risk inherent in these strategies varies meaningfully, since not only are the slices of the pie being adjusted, but in many cases the overall size of the pie changes as well. As it relates to fees, smart beta products tend to be more expensive than the indexed ETFs employed in the first method.

Building a stock portfolio today is more nuanced than simply buying an index fund or a group of individual stocks. There is a large and diverse middle ground with strategies to fit the risk and return objectives of every individual. At BKD Private Client™, we offer a variety of approaches to stock investing to meet the unique needs and preferences of our clients. Submit the Contact Us form below or reach out to your BKD Trusted Advisor™ today to learn more about how we can create a strategy for you.

Services may include investment advisory services provided by BKD Wealth Advisors, LLC (“BKDWA”), an SEC-registered investment adviser, and/or accounting, tax and related solutions provided by BKD, LLP. Past performance may not be indicative of future results. This communication is intended to be informational and educational in nature. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, strategy, or product (including the investments and/or strategies recommended or undertaken by BKDWA, or any non-investment related content, made reference to directly or indirectly in this communication) will be profitable, equal any historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this communication serves as the receipt of, or as a substitute for, personalized investment advice.

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