What Is Activity-Based Management?

Activity-based management (ABM) is a system for determining the profitability of every aspect of a business so that its strengths can be enhanced and its weaknesses can either be improved or eliminated altogether.

Activity-based management (ABM), which was first developed in the 1980s, seeks to highlight the areas where a business is losing money so that those activities can be eliminated or improved to increase profitability. ABM analyzes the costs of employees, equipment, facilities, distribution, overhead, and other factors in business to determine and allocate activity costs.

Understanding Activity-Based Management (ABM)

Activity-based management can be applied to different types of companies, including manufacturers, service providers, non-profits, schools, and government agencies. ABM can provide cost information about any area of operations in a business.

In addition to improving profitability and the overall financial strength of a company, the results of an ABM analysis can help that company produce more accurate budgets and long-term financial forecasts.

Examples of Activity-Based Management (ABM)

ABM can be used, for example, to analyze the profitability of a new product a company is offering, by looking at marketing and production costs, sales, warranty claims, and any costs or repair time needed for returned or exchanged products. If a company is reliant on a research and development department, ABM can be used to look at the costs of operating the department, the costs of testing out new products and whether the products developed there turned out to be profitable.

Another example might be a company that has opened an office in a second location. ABM can help management assess the costs of the running that location, including the staff, facilities, and overhead, and then determine whether any subsequent profits are enough to make up for or justify those costs.

Special Considerations

A lot of the information gathered in activity-based management is derived from information gathered from another management tool, activity-based costing (ABC). Whereas activity-based management focuses on business processes and managerial activities driving organizational business goals, activity-based costing seeks to identify and reduce cost drivers by optimizing resources.

Both ABC and ABM are management tools that help in managing operational activities to improve the performance of a business entity or an entire organization.

Activity-based costing can be considered an offshoot of activity-based management. By mapping business costs like supplies, salaries, and leasing activity to business processes, products, customers, and distribution activity, activity-based costing helps improve overall managerial effectiveness and transparency.

What Is Active Management?

The term active management means that an investor, a professional money manager, or a team of professionals is tracking the performance of an investment portfolio and making buy, hold, and sell decisions about the assets in it. The goal of any investment manager is to outperform a designated benchmark while simultaneously accomplishing one or more additional goals such as managing risk, limiting tax consequences, or adhering to environmental, social, and governance (ESG) standards for investing. Active managers may differ from other is how they accomplish some of these goals.

For example, active managers may rely on investment analysis, research, and forecasts, which can include quantitative tools, as well as their own judgment and experience in making decisions on which assets to buy and sell. Their approach may be strictly algorithmic, entirely discretionary, or somewhere in between.

By contrast, passive management, sometimes known as indexing, follows simple rules that try to track an index or other benchmark by replicating it. Those who advocate for passive management maintain that the best results are achieved by buying assets that mirror a particular market index or indexes. Their contention is that passive management removes the shortfalls of human biases and that this leads to better performance. However, studies comparing active and passive management have only served to keep the debate alive about the respective merits of either approach.

Understanding Active Management

Investors who believe in active management do not support the stronger forms of the efficient market hypothesis (EMH), which argues that it is impossible to beat the market over the long run because all public information has already been incorporated in stock prices.

Those who support these forms of the EMH insist that stock pickers who spend their days buying and selling stocks to exploit their frequent fluctuations will, over time, likely do worse than investors who buy the components of the major indexes that are used to track the performance of the wider markets over time. But this point of view narrows investing goals into a single dimension. Active managers would contend that if an investor is concerned with more than merely tracking or slightly beating a market index, an active management approach might be better suited for the task.

Active managers measure their own success by measuring how much their portfolios exceed (or fall short of) the performance of a comparable unmanaged index, industry, or market sector.

For example, the Fidelity Blue Chip Growth Fund uses the Russell 1000 Growth Index as its benchmark. Over the five years that ended June 30, 2020, the Fidelity fund returned 17.35% while the Russell 1000 Growth Index rose 15.89%. Thus, the Fidelity fund outperformed its benchmark by 1.46% for that five-year period. Active managers will also assess portfolio risk, along with their success in achieving other portfolio goals. This is an important distinction for investors in retirement years, many of whom may have to manage risk over shorter time horizons.

Strategies for Active Management

Active managers believe it is possible to profit from the stock market through any of a number of strategies that aim to identify stocks that are trading at a lower price than their value merits. Their strategies may include researching a mix of fundamental, quantitative, and technical indications to identify stock selections. They may also employ asset allocation strategies aligned with their fund’s goals.

Many investment companies and fund sponsors believe it’s possible to outperform the market and employ professional investment managers to manage the company’s mutual funds. They may see this as a way to adjust to ever-changing market conditions and unprecedented innovations in the markets.

Disadvantages of Active Management

Actively managed funds generally have higher fees and are less tax-efficient than passively managed funds. The investor is paying for the sustained efforts of investment advisers who specialize in active investment, and for the potential for higher returns than the markets as a whole.

An investor considering active management should take a hard look at the actual returns after fees of the manager.

Advantages of Active Management

A fund manager’s expertise, experience, and judgment are employed by investors in an actively managed fund. An active manager who runs an automotive industry fund might have extensive experience in the field and might invest in a select group of auto-related stocks that the manager concludes are undervalued.

Active fund managers have more flexibility. There is more freedom in the selection process than in an index fund, which must match as closely as possible the selection and weighting of the investments in the index.

Actively managed funds allow for benefits in tax management. The flexibility in buying and selling allows managers to offset losers with winners.

Managing Risk

Active fund managers can manage risks more nimbly. A global banking exchange-traded fund (ETF) may be required to hold a specific number of British banks. That fund is likely to have dropped significantly following the shock Brexit vote in 2016. An actively managed global banking fund, meanwhile, might have reduced its exposure to British banks due to heightened levels of risk.

Active managers can also mitigate risk by using various hedging strategies such as short selling and using derivatives.

Active Management Performance 

There is plenty of controversy surrounding the performance of active managers. Their success or failure depends largely on which of the contradictory statistics is quoted.

Over 10 years ending in 2021, active managers who invested in domestic small growth stocks were most likely to beat the index. A study showed that 88% of active managers in this category outperformed their benchmark index before fees were deducted.