Market timing is an important instrument of active portfolio management. In a debt portfolio, market timing is attempted in response to the anticipated changes in interest rates. The main tool of response to these expectations is modification of portfolio’s duration. In an equity portfolio, market timing refers to response to changes in equity market’s risk premium. If the market were expected to earn high premium (Bull phase), an equity portfolio’s systematic risk would be increased. If the risk premium were to become negative (Bear phase), portfolio’s systematic risk would be pruned. In effect, modification of systematic risk is the instrument of market timing in an equity portfolio. Investment management literature has tended to treat market timing of debt portfolio differently from that of equity portfolio. This paper attempts to view market timing of different asset classes from a unified point of view. The paper builds a general, yet elementary model of market timing that addresses all financial assets. It is shown that sensitivity of a portfolio’s value to changes in the risk premium of the market would depend on portfolio’s duration and its systematic risk. Under the circumstances specific to different asset classes, duration management or management of systematic risk could assume significance. The model proceeds to illustrate these implications for management of equity, debt and balanced portfolios.

Portfolio managers follow two different approaches to managing the money—active portfolio management and passive portfolio management. Passive portfolio management is based on the notion of Efficient Market Hypothesis (EMH). In an informationally efficient market, security prices would always reflect all information as prices instantaneously adjust to reflect any new information. Under such situations, neither security mispricing nor asset return patterns are likely to persist. This would make active asset management irrelevant.

Passive fund managers try to track an index. Therefore, they do not indulge in security research and stock selection. They do not try to forecast the movement of the economy and sectors. By eschewing these activities, they reduce the expenses of managing the portfolio considerably. They argue that active management does not produce superior returns net of expenses. Several studies have shown that over the long-term, index funds are likely to outperform a majority of actively managed funds of similar risk (Elton, Gruber and Blake, 1996; Gruber, 1996; Carhart, 1997). Davis (2001) showed that neither the growth nor value investment styles outperformed indexes over the long-term.