Investment manager

What Is an Investment Manager?

An investment manager is a financial professional or firm responsible for managing a portfolio of securities and other assets on behalf of clients. This role falls under the broader financial category of asset management, which encompasses a wide range of services aimed at growing and preserving wealth. An investment manager makes investment decisions, executes trades, and monitors performance to achieve specific financial goals, such as capital appreciation, income generation, or wealth preservation. They typically work with individuals, institutions, and sometimes even other financial advisors, adhering to a defined investment policy statement that outlines objectives, risk tolerance, and constraints. An investment manager is compensated for their services, often through a percentage of assets under management (AUM) or a combination of fees and performance-based incentives.

History and Origin

The concept of professional asset management has roots tracing back thousands of years, with early forms including individuals managing assets for Roman soldiers or Greek masters.¹⁶ However, the modern investment manager began to take shape with the rise of formal financial markets. In the 12th century, "courtiers de change" in France managed debt for agricultural communities.¹⁵ The establishment of the first formal stock exchange in Amsterdam in the early 1600s further laid the groundwork for professional investing.¹⁴

A significant turning point in the professionalization of the investment management industry occurred with the emergence of investment trusts in the United Kingdom before World War I. These trusts promoted the principle of diversification by pooling investor savings into diversified portfolios of securities, leading to the idea of "scientific distribution of risk."¹³ The directors of these early investment trusts effectively functioned as the first professional asset managers.¹²

In the United States, a pivotal development was the passage of the Investment Advisers Act of 1940. This federal law was enacted to regulate and define the responsibilities of investment advisors, providing the legal framework for monitoring those who provide investment advice for a fee. The Act was prompted by a 1935 report to Congress on investment trusts and investment companies. This legislation mandated registration with the Securities and Exchange Commission (SEC) for certain advisors and established requirements for fiduciary duty, ensuring that an investment manager acts in the best interests of their clients.,¹¹

Key Takeaways

• An investment manager oversees and makes decisions regarding a client's investment portfolio.
• They operate within the broader field of asset management and are typically compensated via fees based on assets under management.
• The role of an investment manager involves developing and implementing investment strategies tailored to client objectives and risk profiles.
• Regulatory frameworks, such as the Investment Advisers Act of 1940, govern the conduct and responsibilities of investment managers.
• While some investment managers aim to outperform market benchmarks through active management, others focus on passive investing strategies.

Formula and Calculation

While there isn't a single "formula" for an investment manager's role, their performance is often evaluated using various metrics. A common calculation is the fee structure, often expressed as a percentage of assets under management (AUM).

For example, if an investment manager charges an annual fee of 1% on AUM, the annual fee can be calculated as:

Another key calculation is the portfolio return, which measures the gain or loss of investments over a period. This can be expressed as:

These calculations help clients understand the costs associated with an investment manager's services and the effectiveness of their investment decisions.

Interpreting the Investment Manager

Interpreting the role and effectiveness of an investment manager involves more than just looking at raw returns. Investors should consider the investment manager's adherence to their stated investment objectives and risk tolerance. For instance, an investment manager focused on capital preservation might show lower returns than one pursuing aggressive growth, but they might be more successful in meeting their specific mandate during volatile markets.

It is also crucial to assess the fees charged by an investment manager in relation to the services provided and the performance achieved. High fees can significantly erode returns, even if the gross performance appears strong. Furthermore, understanding the investment manager's investment philosophy and how it aligns with personal financial goals is essential. This includes their approach to asset allocation, security selection, and rebalancing.

Hypothetical Example

Consider an individual, Sarah, who has $500,000 to invest and hires an investment manager. Sarah's primary objective is moderate growth with a balanced risk profile.

1. Initial Investment: Sarah invests $500,000 with the investment manager.
2. Fee Structure: The investment manager charges an annual fee of 0.80% on AUM.
3. First Year Performance: Over the first year, the investment manager invests Sarah's funds in a diversified portfolio of stocks and bonds. The portfolio grows by 7% before fees.
4. Calculation of Growth:
   • Gross portfolio value at year-end: $500,000 * (1 + 0.07) = $535,000
5. Calculation of Fees:
   • Annual fee: $500,000 * 0.0080 = $4,000 (assuming fees are calculated on the initial AUM for simplicity, though often it's an average or ending AUM)
6. Net Portfolio Value:
   • Net portfolio value at year-end: $535,000 - $4,000 = $531,000
7. Net Return:
   • Net return: ($531,000 - $500,000) / $500,000 = 0.062 or 6.2%

In this example, the investment manager helped Sarah achieve a 6.2% net return, demonstrating how fees impact the overall portfolio performance. This scenario highlights the importance of understanding all costs involved when engaging an investment manager.

Practical Applications

An investment manager plays a crucial role across various facets of the financial world. For individual investors, they often serve as financial advisors, helping to build and manage retirement portfolios or wealth for specific life goals. Institutional clients, such as pension funds, endowments, and foundations, rely on investment managers to oversee massive pools of capital, ensuring long-term financial stability and growth.

In the market, investment managers execute trades on behalf of clients, influencing market liquidity and price discovery. Their decisions can reflect broader market sentiment or specific analytical insights. From a regulatory perspective, investment managers are subject to oversight by bodies like the SEC in the United States, which enforces rules designed to protect investors and maintain fair and efficient markets. The Investment Advisers Act of 1940 is a key piece of legislation in this regard, outlining registration requirements, fiduciary duties, and anti-fraud provisions for investment advisors.¹⁰

Moreover, the ethical conduct of an investment manager is paramount. Organizations like the CFA Institute establish a Code of Ethics and Standards of Professional Conduct that guide investment professionals globally, emphasizing integrity, diligence, and placing client interests above personal interests.⁹,⁸ This framework helps maintain public trust in the investment profession.

Limitations and Criticisms

Despite the widespread use of investment managers, there are notable limitations and criticisms, particularly concerning active management. One common critique revolves around the fees charged by an investment manager, which can significantly reduce net returns, especially over long periods.⁷ Academic research often suggests that, on average, actively managed funds struggle to consistently outperform their benchmarks after accounting for costs.⁶,⁵ This raises questions about the value proposition of active management compared to lower-cost index funds or exchange-traded funds (ETFs).

Some studies also point to a lack of persistence in outperformance among active managers, meaning that past success is not a reliable indicator of future performance.⁴ This can make it challenging for investors to identify an investment manager who will consistently generate superior returns. Additionally, criticisms include the potential for conflicts of interest, where an investment manager's compensation or other incentives might not perfectly align with the client's best interests. Regulations aim to mitigate this, but it remains a consideration.

The debate between active and passive investing often highlights these limitations. While passive strategies offer broad market exposure at minimal cost, proponents of active management argue that skilled investment managers can add value by exploiting market inefficiencies, particularly in less efficient markets or during certain economic conditions.³ However, the overall evidence suggests that achieving consistent outperformance through active management is difficult for most. For example, research published by Morningstar has provided empirical evidence on active share as a predictor, finding that high-active-share funds often failed to deliver superior net-of-fee results in many categories.²

Investment Manager vs. Financial Advisor

While the terms "investment manager" and "financial advisor" are sometimes used interchangeably, they represent distinct roles within the financial services industry, though there can be overlap.

An investment manager's core responsibility is the day-to-day management of investments, aiming to optimize portfolio performance based on agreed-upon objectives. A financial advisor, on the other hand, typically provides a wider range of services, including budgeting, debt management, retirement planning, estate planning, and insurance, with investment management being just one component of their offering. While many financial advisors also provide investment management services, not all investment managers act as comprehensive financial advisors.

FAQs

What does an investment manager do?

An investment manager is responsible for making investment decisions and managing a portfolio of assets on behalf of clients. This includes selecting specific securities, allocating assets across different investment classes, and monitoring performance to achieve the client's financial goals.

How is an investment manager compensated?

Typically, an investment manager is compensated through fees based on a percentage of the assets they manage (assets under management, or AUM). Some may also charge flat fees, hourly rates, or performance-based fees.

What is the difference between an active and passive investment manager?

An active investment manager attempts to outperform a specific market benchmark by actively selecting securities, timing the market, or employing other strategies. A passive investment manager, by contrast, seeks to replicate the performance of a market index by holding all or a representative sample of the securities in that index, often through index funds or ETFs.

Are investment managers regulated?

Yes, in the United States, investment managers (who qualify as investment advisers) are regulated by the Securities and Exchange Commission (SEC) or state securities regulators under the Investment Advisers Act of 1940. This regulation imposes fiduciary duties and other requirements to protect investors.,¹

What should I consider when choosing an investment manager?

When selecting an investment manager, consider their fee structure, investment philosophy, historical performance, the level of personalized service they offer, their regulatory standing, and how well their approach aligns with your financial goals and risk tolerance.