What is a portfolio manager?

A portfolio manager is a financial professional or group of professionals who are responsible for purchasing and selling assets in a mutual fund, closed-end fund or exchange-traded fund (ETF). The portfolio manager is responsible for implementing the fund’s specific investment strategy. When a portfolio manager is overseeing a fund that has a small amount of assets, they may have the title of fund manager. When they are overseeing a fund with a large asset base, they may have the title of Chief Investment Officer (CIO).

Portfolio managers are part of a team that includes analysts. These analysts (known as buy-side analysts) are responsible for making recommendations to the portfolio manager based on their proprietary research as well as the input they receive from sell-side analysts. Sell-side analysts represent brokerage houses and investment banks that are looking to receive the fund’s assets. Analysts will make buying or selling recommendations, but ultimately it is the portfolio manager who is responsible for making the buying or selling decision. Portfolio managers will also spend a great deal of time conducting their own research and following the financial news to help supplement the information they receive from their analysts. In addition to buying and selling assets, portfolio managers will frequently meet with large fund investors.

A portfolio manager is either categorized as being an active manager or a passive manager. In the next section, we’ll go over the differences between these two styles and how it can affect an investor’s portfolio.

An active portfolio manager takes an investment approach that seeks to exceed the return of the broader market. An active portfolio manager uses their experience and market knowledge to select the underlying assets of a particular fund in a á la carte fashion. Investors who choose to invest in an actively managed fund are paying for the expertise and experience provided by these portfolio managers. One of the consequences of getting this experience is a fee structure that is generally higher than a passively managed fund. The challenge for the active portfolio manager is to get a return that exceeds the expenses of their particular fund, which are higher than those of a passively managed fund.

An active portfolio manager will typically have their own research methodology or they may be part of a fund group that uses a unique methodology. This methodology is used to select the assets that make up their fund. Although, in recent years, particularly since the financial crisis of 2008-2009, money has been flowing out of actively managed funds, there are still some areas where active management can exceed the high bar that comes with a higher fee structure. One area is in international and emerging growth stocks. In some cases, these funds have mandates that include many nations or regions, allowing a fund manager to shift assets out of certain countries into others. Another opportunity is in the area of fixed income funds, such as bond funds. In this case, an active manager may be able to maintain an investment in sub-investment grade bonds that they see as holding the potential for a return.

The passive portfolio manager has an investment approach that ties the performance of their fund to an underlying index. The index a portfolio manager uses for an income fund will complement the investment objective of the fund. A portfolio manager overseeing an income fund may look at the performance of a fund such as the iShares Dow Jones Select Dividend Index Fund. If the manager has oversight for a growth fund, they may look at an index fund such as the Vanguard Growth Index. In 2017, nearly $700 million flowed into index funds.

One of the key benefits of passive investing is lower fees. The lower the fees, the sooner a fund can get “into the black”. However, in trying to stay closely tracked to an index, a passive fund in practice will not exceed the return of the index fund and, when fees are included – no matter how minimal – they may underperform the prescribed market index.

The decision to be an active or passive portfolio manager often comes down to a change in philosophy. The passive portfolio manager prescribes to the Efficient Market Hypothesis (EMH). This is a well-known investment philosophy that states that current market prices “reflect all currently available information” and reflects a company’s intrinsic value. For the passive portfolio manager, the EMH means that individual asset selection will not add a meaningful return. Recent research has supported the EMH. However, in some cases, active portfolio management may still provide better performance:

An investor might consider active portfolio management if they:

• Have an above average risk tolerance
• Are comfortable with more buying and selling activity in their portfolio
• Are comfortable investing in international or emerging market sectors and fixed income assets where active management is still seen as offering an advantage

An investor might consider passive portfolio management if they:

• Are seeking the lowest fee structure
• They have a moderate to low risk tolerance
• They are comfortable with a performance that, after fees, will be at or slightly below the performance of the underlying index

The active versus passive management debate is one that will not be resolved anytime soon. As of 2018, just over a third of investor’s capital was invested in passive funds. Active equity funds still held around $10 trillion of assets, but the trend towards passive funds is real.

To be a portfolio manager, an individual must have a professional license from the Financial Industry Regulatory Authority (FINRA). In some cases, a portfolio manager may be required to have multiple FINRA licenses. If they are managing a portfolio with over $25 million in assets, they will have to be registered with the Securities & Exchange Commission (SEC). In addition, many portfolio managers find it helpful to become a Chartered Fund Analyst (CFA).

While experience is important when considering a portfolio manager, investors should also look for other qualities including:

• Innovative Thinking – Burton Malkiel, a professor at Princeton University once famously quipped that “a blindfolded monkey throwing darts at the stock listings” could do as well as a professional money manager. While that may be true, history has sided with portfolio managers who find innovative approaches that have resulted in higher returns.
• Critical Thinking – As important to having the ability to look for innovative solutions is the ability to filter out the noise that surrounds individual assets or funds and look for what’s really happening. This is particularly important in a 24-hour news cycle where a favorable or unfavorable earnings report can dramatically skew a stock or fund’s performance.
• Decisive Action – The market moves fast. A common mistake investors make is “analysis paralysis”. A successful portfolio manager knows when to take an appropriate buy or sell action.