Investment Management

This article focuses on investment management. It provides an overview of the history of investment management and the investment management industry. Active investment management, passive investment management practices, and management services in different investment environments such as corporations, endowments, and households, are discussed. Investment portfolios, pension funds, performance fees, and assets are described. The issues associated with the U.S. government's regulation of the investment management industry are also addressed.

Keywords Active Investment Management; Assets; Benchmark Return; Employee Retirement Income Security Act; Endowments; Exceptional Return; Face-Amount Certificate Company; Federal Government; Fiduciaries; Information Ratio; Investment Management; Management Company; Objective Value; Opportunity Loss.; Passive Investment Management; Pension Funds; Pension Surplus; Performance Fees; Portfolios; Transaction Cost

Finance > Investment Management

Overview

Investment management, also called money management and asset management, refers to the process of investment analysis involving portfolio management, budget making, banking, tax planning, and investment risk assessment. Investment managers work for pension funds, corporations, governments, institutions, endowments, foundations, and high net worth individuals. Investment managers help grow and mange assets through multiple products and services including analysis, research, and risk management. Investment management is divided into two main types: Active investment management and passive investment management.

• Active investment management is an approach based on informed and independent investment decisions. Active investment management generally involves the frequent buying and selling of bonds. Active investment management has as its primary goal to outperform benchmark returns.
• Passive investment management, also referred to as indexing, involves investing in a wide range of assets classes and working to match the overall performance of the market. Passive investment management generally involves holding bonds to the point at which they mature.

Investment managers, both active and passive money managers, work to control and balance investment return, risk, and cost. Investment managers control return, risk, and cost by analyzing the following variables within a client's portfolio (Grinold, 2005):

• Exceptional return: Exceptional return refers to the residual return plus benchmark timing return.
• Benchmark return: Benchmark return refers to the standard value against which the performance of a security, index, or investor can be measured.
• Opportunity loss: Opportunity loss refers to the estimated lost resulting from not choosing the best option or solution.
• Transaction cost: Transaction cost refers to the cost resulting from buying or selling assets including commissions.
• Objective value: Objective value refers to the prevailing value established by the market.
• Information ratio: Information ratio refers to the expected exceptional return divided by the amount of risk assumed in pursuit of that exceptional return.

The following sections provide an overview of the history of investment management and the investment management industry. This overview will serve as the foundation for later discussion of investment management practices and services in corporations, endowments, and households. The issues associated with the U.S. government's regulation of the investment management industry are also addressed.

The History of Investment Management

The field of investment management began in the United States on a large scale following the Great Depression of the 1930s. Following the Great Depression, the public and private sectors, in an effort to rebuild and stabilize the economy, began to actively manage investment portfolios through analysis, research, and risk management. The history of investment management during the twentieth century is characterized by shifting paradigms. The field of investment management has experienced paradigm shifts during the twentieth century regarding the role and purpose of organization and management. The organization and management paradigm in investment management has changed in the following ways over the last century (Ellis, 1992):

• 1940s: Investment management in the 1940s was characterized by insurance plan dominated pension funds.
• 1950s: Investment management in the 1950s was characterized by the growth of corporate pension funds. Pension funds refer to a category of funds that are collected and reserved to pay employees' pensions when they retire from active employment.
• 1960s: Investment management in the 1960s was characterized by a growth in overall pension fund assets.
• 1970s: Investment management in the 1970s was characterized by the multi-manager concept of pension fund investing in which plans divide the control of their funds among multiple investment managers. Pension plans and endowments began to prioritize the role of investment managers and compensate investment managers with high salaries.
• 1980s: Investment management in the 1980s was characterized by an increasingly diversified asset and manager classification system. The categories of value manager, growth manager, and sector rotator emerged. Investment manager consultants became common. Investment products and options increased.
• 1990s: Investment management in the 1990s was characterized by a growth in investment management fees. Performance fees, also referred to as investment management fees, became common practice. Performance fees are an amount paid to the investment manager of a hedge fund once positive performance has been achieved or reached. In addition, investment managers in the 1990s became ever-more specialized and classified according to an ever-expanding set of categories. As a result of the changes in management categories that occurred in the 1990s, investment managers today may be immunized, dedicated, structured, or indexed. Managers are considered to be either value managers or growth managers. Managers can specialize in private placements or extended markets.

Ultimately, the changes in the field of investment management throughout the twentieth century were related to changes in the structure and operations of the market. The structure of the investment management industry has changed from concentrated to increasingly diversified or fragmented to capitalize on the increasingly efficient market (Ennis, 1997). In the twenty-first century, investment managers, who are often mobile and independent agents, are swiftly responsive to market changes.

The Investment Management Industry

The primary professional investment management association is the CFA Institute. The CFA Institute, which reports 90,000 members in 134 societies, is the association of investment professionals that awards the Chartered Financial Advisers (CFA) and the Certificate in Investment Performance Measurement (CIPM) designations and certificates. Corporations, such as Citigroup, Mellon Financial Corporation, Ashland Partners, State Street, ING, Morgan Stanley, Nicholas Applegate, SS & C Technologies, UBS, and the AIG Global Investment Group, seek out investment managers with CFA Institute certification. The Chartered Financial Advisers (CFA) certification program is a three-year program with three levels of exams. The Certificate in Investment Performance Measurement (CIPM) certification program is designed to train performance professionals to meet investment industry needs.

Development of the CFA Institute

The CFA Institute has its origins in the investment societies of the early twentieth century such as the Investment Analyst Society of Chicago, established in 1925 to promote investment education and professionalism, and the New York Society of Security Analysts (NYSSA) established in 1937. In 1947, the National Federation of Financial Analysts Societies (NFFAS) formed. In 1959, the NFFAS board formed the Institute of Chartered Financial Analysts (ICFA) to provide a certification of competence. In 1961, the ICFA was formally incorporated and in 1963 the first investment manager certification examination was offered. In 2004, the ICFA changed its name to CFA Institute to better express its identity and strengthen brand recognition.

CFA Institute Code of Ethics

The CFA Institute promotes a code of ethics and standards of professional investment management conduct. The Code of Ethics and Standards of Professional Conduct includes a code of ethics, research objectivity standards, trade management guidelines, asset manager code, and soft dollar standards. The CFA Institute's Code of Ethics concerns ethical management behavior in the following areas: Professionalism; integrity of capital markets; duties to clients; duties to employers; investment analysis; recommendation, and action; conflict of interest; and responsibilities as a CFA institute member.

• Professionalism: Investment managers must posses a knowledge of the law; demonstrate independence and objectivity; and reject misrepresentation and misconduct.
• Integrity of capital markets: Investment managers with material nonpublic information should not use the information to affect the value of an investment. Investment managers must not engage in market manipulation to distort prices or inflate trading volume to mislead market participants.
• Duties to clients: Investment managers must demonstrate loyalty, prudence, care, fair dealing, suitability, performance presentation, and preservation of confidentiality with clients.
• Duties to employers: Investment managers must demonstrate loyalty and fair compensation arrangements with their employers.
• Investment analysis, recommendations, and action: Investment managers must demonstrate diligence and reasonable basis for making investment recommendations and taking investment actions.
• Conflicts of interest: Investment managers must disclose all conflicts of interest. Investment managers must give priority of transactions to transactions for clients and employers over transactions that would benefit managers or corporations.
• Referral fees: Investment managers must disclose any compensation or benefit received for the recommendation of financial products or services.

Applications

Investment Management Products & Services

Investment management falls into three main groups or categories: Corporations (pension funds), endowment funds, and households. Investments are made with specific time horizons in mind: The long run, the trading horizon, the decision horizon, then planning horizon, and the planning sub-horizons.

• Trading horizons are the shortest time in which an investment manager can carry out or revise a transaction. The institution rather than individual investment managers and analysts establish the length of the trading horizon.
• Decision horizons are the period of time between deciding to revise a portfolio and executing the decision.
• Planning horizons are the period of time over which things matter to the decision maker. Planning horizons are generally multiple decades long.
• Planning sub-horizons are directly connected to targeted issues and concerns such as retirement. For example, when investment managers build the portfolio for retirement purposes, the length of time until retirement is called the planning sub-horizon.
• Long run horizons are a series of short periods linked to the faraway investment objective or goal.

Despite the shared forecast variables, optimal investment policy is not general to all investment environments and clients. Investment policy varies between corporations, endowments, and households.

Pension Fund Management

Corporate investment management generally focuses on corporate pension fund management. Investment managers attempt to grow the pension surplus within their organizations. Pension surplus refers to the difference between assets and liabilities. The main pension options available to corporate employees are defined benefit pension plans and cash-balance pension plans. Employer-based retirement and workplace savings plans are a form of financial risk protection. Investment managers oversee and administer pensions, individual retirement accounts, 457 deferred compensation plans, 401 (k) plans, and 403(b) plans. Pensions are programs that provide employees with retirement income after they meet minimum age. Individual retirement accounts (IRAs) are accounts to which an individual can make annual contributions of earnings up to a pre-determined amount. A 457 deferred compensation plan is a supplemental retirement savings program that allows individuals to make contributions on a pre-tax basis. The 401(k) plan is a retirement investment plan that allows an employee to put a percentage of earned wages into a tax-deferred investment account. The 403(b) plan is a retirement investment plan, which is offered by non-profit organizations, that allows an employee to put a percentage of earned wages into a tax-deferred investment account. The Employee Retirement Income Security Act (ERISA), which is the federal legislation that governs the administration and design of employer pension, health and welfare plans, regulates corporate investment management practices, products, and services. According to the Employee Retirement Income Security Act, corporate investment managers have a fiduciary responsibility to manage employee pensions in the best financial interests of employees.

Endowment Fund Management

The investment management practices for endowments vary significantly from those used in corporations. Endowment fund management is more similar to individual or household investment management than corporate investment management. The investment manager of an endowment considers variables, such as anticipated gifts, bequests, shadow investments, and cost of operations, when making investment decisions. Investment decisions usually follow the board of director generated and approved investment guidelines. Endowment fund portfolios generally include a percentage allocated to equities, a percentage allocated to fixed-income investment products, and a percentage allocated to alternative investments including real estate or hedge funds. Investment managers monitor the portfolio in an ongoing basis to ensure that the portfolio matches established investment policy and the portfolio allocation guidelines. Endowments usually have an endowment spending policy in place to control annual spending and ensure that annual spending decisions are in compliance with endowment goals and objectives.

Investment Management

In households, investment management is undertaken by individuals who may or may not have financial training. Households plan for the financial burden of retirement and college tuition through investment choices throughout the family life cycle. Defined-benefit pension plans, which were once the ubiquitous retirement investment choice, are being replaced by defined contribution plans in which the employee must decide on the mix of investments. Defined benefit plans specify benefits as a fraction of final pay scale before retirement and require no management by the household. Household investors are often overwhelmed with investment choices. For example, there are over 9,000 different mutual funds available for purchase by individual household investment managers. Household investment managers must manage investment risk as they plan for targeted expenditures such as home purchase, retirement, or college tuition. There are three main approaches to risk control or risk management in household investment management: Hedging, diversification, and insuring (Merton, 2003).

Issues

U.S. Government Regulation of Investment Management

The U.S. Securities and Exchange Commission (SEC), the U.S. governmental body responsible for protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital formation, regulates investment management activities. The U.S. Securities and Exchange Commission includes a Division of Investment Management. The Division of Investment Management regulates investment companies (such as mutual funds, closed-end funds, unit investment trusts (UIT), exchange-traded funds, and interval funds), including variable insurance products, and federally registered investment advisers. The U.S. Securities and Exchange Commission defines investment companies as any issuer which is or holds itself out as being engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting, or trading in securities; is engaged or proposes to engage in the business of issuing face-amount certificates of the installment type; or is engaged or proposes to engage in the business of investing, reinvesting, owning, holding, or trading in securities, and owns or proposes to acquire investment securities having a value exceeding 40 percent of the value of such issuer's total assets on an unconsolidated basis.

Categories of Investment Companies

The U.S. Securities and Exchange Commission divides investment companies into three main categories: Face-amount certificate company; unit investment trust; and management company. A face-amount certificate company refers to an investment company that is engaged in the business of issuing face-amount certificates of the installment type. A unit investment trust, according to the Securities and Exchange Commission, refers to an investment company which is organized under a trust indenture, contract of custodianship or agency, or similar instrument; does not have a board of directors; and issues only redeemable securities, each of which represents an undivided interest in a unit of specified securities. Unit investment trusts do not include a voting trust. A management company refers to any investment company other than a face-amount certificate company or a unit investment trust.

There are two main laws that regulate investment management practices: The Investment Company Act of 1940 and the Investment Advisers Act of 1940.

• The Investment Company Act of 1940 considers the following actions by investment companies to adversely affect the national public interest and the interest of investors and, as a result, to be illegal: Investors acquire or surrender securities issued by investment companies without adequate information concerning the character of such securities and the circumstances of such companies and their investment management; investment companies are operated in the interest of affiliated persons rather than in the interest of all classes of such companies' security holders; investment companies issue securities containing inequitable or discriminatory provisions, or fail to protect the preferences and privileges of the holders of their outstanding securities; investment companies are managed by irresponsible persons; investment companies employ unsound or misleading methods or are not subjected to adequate independent scrutiny; investment companies are reorganized or become inactive without the consent of their security holders; and investment companies operate without adequate financial assets or reserves.
• The Investment Advisers Act of 1940 considers the following actions of investment advisers to adversely affect the national public interest and the interest of investors and, as a result, to be illegal: Investment advisers distribute their advice or analyses to clients by the use of the mails and means and instrumentalities of interstate commerce. Investment advisers distribute their advice or analyses related to the purchase and sale of securities traded on national securities exchanges and in interstate over-the-counter markets in such volume as substantially to affect interstate commerce, national securities exchanges, the national banking system, and the national economy.

In addition to the regulation of the activities of investment companies and investment advisers, the U.S. Securities and Exchange Commission oversees the investment adviser federal registration process. The U.S. Securities and Exchange Commission requires investment advisers to be registered with the federal government. The registration process involves supplying the U.S. Securities and Exchange Commission with the following information: The name and form of organization under which the investment adviser engages or intends to engage in business; the education, the business affiliations for the past ten years, and the present business affiliations of such investment adviser; the nature of the business of such investment adviser, including the manner of giving advice and rendering analyses or reports; a balance sheet certified by an independent public accountant and other financial statements; the nature and scope of the authority of such investment adviser with respect to clients' funds and accounts; and the basis upon which such investment adviser is compensated.

Registered investment advisers and managers are required to have and submit to the U.S. Securities and Exchange Commission and clients written compliance programs to ensure that the investment managers do not violate the rights of their clients. Compliance programs must include written descriptions of the following issues: Portfolio management processes; the accuracy of disclosures made to investors, clients, and regulators; proprietary trading by investment mangers; safeguarding of client assets from conversion or inappropriate use of the investment manager; the accurate creation of required records and their privacy and maintenance; safeguards for the privacy protection of client records and information; trading practices; marketing advisory services; and business continuity plans. Ultimately, the U.S. Securities and Exchange Commission considers investment advisers and managers to be fiduciaries or trust holders for their clients. As such, the U.S. Securities and Exchange Commission requires that investment managers and companies behave in an ethical manner toward their clients.

Conclusion

In the final analysis, the field of investment management is a multifaceted form of investment analysis involving investments, portfolio management, budget making, banking, tax planning, and investment risk assessment. The tools, practices, and services of investment management vary based on the investment environments and clients.

Terms & Concepts

Benchmark Return: The standard value against which the performance of a security, index, or investor can be measured.

Employee Retirement Income Security Act: Federal legislation that governs the administration and design of employer pension, health and welfare plans.

Exceptional Return: Residual return plus benchmark timing return.

Face-Amount Certificate Company: An investment company which is engaged or proposes to engage in the business of issuing face-amount certificates of the installment type, or which has been engaged in such business and has any such certificate outstanding.

Federal Government: Form of government in which a group of states recognizes the sovereignty and leadership of a central authority while retaining certain powers of government.

Fiduciaries: Parties that hold something of value in trust for an individual or group.

Information Ratio: The expected exceptional return divided by the amount of risk assumed in pursuit of that exceptional return.

Investment Management: The process of investment analysis involving investments, portfolio management, budget making, banking, tax planning, and investment risk assessment.

Management Company: Any investment company other than a face-amount certificate company or a unit investment trust.

Objective Value: Prevailing value established by the market.

Opportunity Loss: The estimated loss resulting from not choosing the best option or solution.

Pension Funds: A category of funds that are collected and reserved to pay employees' pensions when they retire from active employment.

Pension Surplus: The difference between assets and liabilities.

Transaction Cost: Costs resulting from buying or selling assets including commissions.

Bibliography

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Demarzo, P. M., Fishman, M. J., He, Z., & Wang, N. (2012). Dynamic agency and the q theory of investment. Journal of Finance, 67, 2295-2340.Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=83485970&site=ehost-live

Division of Investment Management. (2007). U.S. Securities and Exchange Commission. Retrieved August 29, 2007, from http://www.sec.gov/divisions/investment.shtml

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Grinold, R. (2005). Implementation efficiency. Financial Analysts Journal, 61, 52-64. Retrieved August 29, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=18486605&site=ehost-live

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Suggested Reading

Davanzo, L., & Nesbitt, S. (1987). Performance fees for investment management. Financial Analysts Journal, 43, 14-20. Retrieved August 29, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=6936269&site=ehost-live

Halpern, P., Calkins, N., & Ruggels, T. (1996). Does the emperor wear clothes or not? The final word (or almost) on the parable of investment management. Financial Analysts Journal, 52, 9-15. Retrieved August 29, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=9702215231&site=ehost-live

Parwada, J., & Faff, R. (2005). Pension plan investment management mandates: An empirical analysis of manager selection. Journal of Financial Services Research, 27, 77-98. Retrieved August 29, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=16731579&site=ehost-live