The Passive Strategy

Portfolio Management Strategy

1. The Passive Strategy
A natural outcome of a belief in efficient markets is to employ some type of passive strategy in owning and managing common stocks. If the market is highly efficient, impounding information into prices quickly and on balance accurately, no active strategy should be able to outperform the market on a risk-adjusted basis. The efficient market hypothesis (EMH) has implications for fundamental analysis and technical analysis, both of which are active strategies for selecting common stocks.

Passive strategies do not seek to outperform the market but simply to do as well as the market. The emphasis is on minimizing transaction costs and time spent in managing the portfolio, because any expected benefits from active trading or analysis are likely to be less than the costs. Passive investors act as if the market is efficient and accept the consensus estimates of return and risk, recognizing current market price as the best estimate of a security's value.

An investor can simply follow a buy-and-hold strategy for whatever portfolio of stocks is owned. Alternatively, a very effective way to employ a passive strategy with common stocks-is to invest in an indexed portfolio. We will consider each of these strategies in turn.