What is the difference between active and passive investing and why is a specificbenchmark required when comparing the two investment strategies? Use the table below tocreate An active investment (portfolio) that invests in all the 5 stocks (at least 5%) but shouldoutperform the market (if the analyst’s predictions are correct). The portfolio is currentlyinvested passively, and each stock is invested in equal amounts.Stock Current market Price Current Valuation Weighting in a passive portfolioAXW $12.52 $10.25 20%NAQ $2.55 $2.75 20%PLB $42.96 $44.61 20%UGD $1.75 $0.98 20%MER $108.65 $106.54 20%Question 3: We know that in an efficient market, investors are unable to generate returnsconsistently above the market, and hence passive investing is suitable. Explain, if marketswould remain efficient if ALL investors invested passively. Now explain if markets wouldremain efficient if there was one active investor?Question 4: Explain the reasons why the textbook uses the example of pension funds to provethat markets are efficient? Further explain, what were the reasons that pension fundsunderperform their benchmark. Is the evidence of mutual fund performance for retailinvestors any better than the evidence for pension funds? Why is this the case?Question 5: Berk (2005) provides a theoretical framework that explains how fund managers’returns eventually equal benchmark returns. Explain how investors choose fund managers toinvest with and why their returns eventually fall to the returns of the benchmark. Furtherexplain if this theory explains if markets are efficient or inefficient?

Active investing involves a hands-on approach where the investor or fund manager makes specific investments with the goal of outperforming an investment benchmark index. This strategy requires a lot of research and decision making. Passive investing, on the other hand, involves less buying and selling and often results in investing in an index fund. The goal is to mimic the investment holdings and returns of a particular index.

A specific benchmark is required when comparing the two investment strategies to measure the performance of the portfolio against a standard. It helps to understand whether the active strategy is adding value compared to a passive strategy.

Creating an active portfolio with the given stocks would involve investing more in the stocks predicted to outperform the market and less in those predicted to underperform. For example, if the analyst predicts that NAQ and PLB will outperform the market, the portfolio could have a higher percentage of these stocks.

Question 3: If all investors invested passively, markets would not remain efficient. This is because market efficiency relies on the belief that the market price of a security at any given point in time accurately reflects all available information. However, if there was one active investor, they could potentially exploit mispriced securities, leading to inefficiencies.

Question 4: The textbook uses the example of pension funds to prove that markets are efficient because these funds are managed by professional investors who have access to all available information. However, pension funds often underperform their benchmark due to various reasons such as high management fees, transaction costs, and regulatory constraints. The evidence of mutual fund performance for retail investors is not necessarily better than the evidence for pension funds. This is because retail investors also face similar challenges such as high fees and lack of access to certain investment opportunities.

Question 5: Berk's (2005) theoretical framework suggests that investors choose fund managers based on their past performance. However, as more investors choose a particular fund, the returns eventually fall to the returns of the benchmark due to increased competition and market efficiency. This theory suggests that markets are efficient as it becomes increasingly difficult for fund managers to outperform the market consistently.