Money managers

Money managers, also known as investment managers or asset managers, are financial professionals or firms that manage investment portfolios on behalf of individuals, institutions, or other entities. Their primary goal within the broader field of portfolio management is to grow and preserve their clients' capital by investing in various securities and asset classes. Money managers make investment decisions, execute trades, and monitor the performance of portfolios according to specific investment objectives and risk tolerances agreed upon with their clients.

History and Origin

The concept of managing wealth for others has roots in ancient civilizations, where individuals or groups oversaw assets like grain, livestock, or land²⁴, ²⁵. However, the modern asset management profession began to take shape in Britain after 1700, with the development of organized borrowing and savings vehicles²³.

A significant turning point in the evolution of money managers came in the 19th and early 20th centuries with the rise of new financial institutions, including investment trusts and mutual funds²². The Great Depression in the 1930s highlighted the need for greater regulation in the financial markets. This led to the enactment of the Investment Advisers Act of 1940 in the United States, which regulates investment advisers and establishes requirements for their registration and conduct²⁰, ²¹. This legislation, along with the Investment Company Act of 1940, helped bring structure and transparency to an industry that previously operated with less oversight¹⁸, ¹⁹. The Investment Advisers Act of 1940 specifically defines an investment adviser as any person or firm that, for compensation, engages in the business of advising others about securities or issuing reports or analyses concerning securities.

Key Takeaways

• Money managers oversee investment portfolios for clients, aiming to achieve specific financial goals.
• They engage in various activities, including investment selection, risk management, and performance monitoring.
• The industry has a long history, with modern regulations like the Investment Advisers Act of 1940 shaping its professional standards.
• Clients often delegate investment decisions to money managers due to their expertise, time constraints, or access to sophisticated tools.
• Money managers can operate under different fee structures, such as asset-based fees or performance fees.

Interpreting the Money Manager

Interpreting the role and effectiveness of a money manager involves understanding their investment philosophy, fee structure, and historical performance. A client evaluates a money manager based on whether their approach aligns with their own financial goals and risk tolerance. For example, some money managers employ an active management strategy, aiming to outperform market benchmarks through security selection and market timing. Others may utilize a passive management approach, seeking to replicate the performance of a specific market index.

Performance metrics like risk-adjusted returns, such as the Sharpe ratio, are crucial for assessing a money manager's ability to generate returns relative to the risk taken. It is also important to consider the consistency of their performance over various market cycles and compare it against relevant benchmarks and peers. Transparency in reporting and clear communication about investment strategies are essential for a client to effectively interpret a money manager's value proposition.

Hypothetical Example

Imagine Sarah, a 45-year-old professional, has accumulated a significant amount in her retirement savings and wants professional help managing her investments. She decides to engage a money manager. Sarah has a moderate risk tolerance and her primary goal is long-term capital appreciation, specifically aiming for her portfolio to grow enough to fund her retirement in 20 years.

The money manager, after understanding Sarah's objectives and risk profile, constructs a diversified portfolio consisting of equities, fixed income, and a small allocation to alternative investments. The manager invests in a mix of large-cap and mid-cap stocks for growth potential, and high-quality corporate bonds for stability and income. They also incorporate a few exchange-traded funds (ETFs) to gain exposure to specific sectors without excessive individual stock risk.

Over the next year, the money manager regularly provides Sarah with performance reports, explaining portfolio changes and market insights. When market volatility increases, the manager explains their strategy for navigating the downturn, perhaps by rebalancing the portfolio to maintain Sarah's target asset allocation. This ongoing communication and adherence to Sarah's pre-defined objectives demonstrate the money manager's role in actively managing her wealth.

Practical Applications

Money managers play a vital role across various facets of the financial landscape:

• Individual Investors: Many individual investors, particularly those with substantial assets or complex financial situations, hire money managers to handle their investment portfolios. This can include managing brokerage accounts, retirement accounts like IRAs, or trust funds.
• Institutional Investors: Pension funds, endowments, foundations, and insurance companies often delegate the management of their vast assets to institutional money managers. These managers handle large-scale portfolios, often specializing in specific asset classes or investment strategies. The worldwide growth of institutional asset management has been significant, supported by demographic changes and financial liberalization¹⁶, ¹⁷. Total assets under management (AUM) at the world's 500 largest asset managers reached $128.0 trillion at the end of 2023, marking a 12.5% annual growth¹⁵.
• Mutual Funds and Hedge Funds: Money managers are central to the operation of mutual funds and hedge funds. They make the investment decisions for the collective pool of assets within these funds, aiming to achieve the fund's stated objectives for all investors.
• Financial Planning: While distinct, money management is often integrated into comprehensive financial planning services. Financial planners may either manage assets directly or work with external money managers to implement investment strategies for their clients.
• Wealth Management: High-net-worth individuals and families often utilize money managers as part of a broader wealth management strategy, which can encompass not only investments but also tax planning, estate planning, and philanthropic advice.

Limitations and Criticisms

While money managers offer expertise and convenience, there are several limitations and criticisms to consider:

• Fees: Money managers charge fees for their services, which can erode investment returns over time. These fees can be a percentage of assets under management (AUM), performance-based fees, or a combination¹⁴. Critiques often highlight that while active managers charge higher fees, their net-of-fee performance frequently lags behind passive alternatives, particularly for readily traded, well-known holdings¹², ¹³. The average active manager, before costs, may earn the same return as the average passive manager, but higher costs for active management can lead to lower after-cost returns on average¹¹.
• Underperformance of Active Management: A common criticism, particularly in academic circles, is that many actively managed funds fail to consistently outperform their benchmarks after fees⁹, ¹⁰. This has fueled the debate between active and passive investing, with some arguing for the efficiency of markets making it difficult for active managers to consistently generate alpha⁸. However, some research suggests that active management can outperform in less efficient markets or during specific market conditions, such as bear markets⁵, ⁶, ⁷.
• Conflicts of Interest: Despite regulations like the Investment Advisers Act of 1940 which aimed to eliminate or expose conflicts of interest⁴, potential conflicts can still arise. For instance, a money manager might be incentivized to recommend certain products that offer higher commissions, even if they are not the most suitable for the client.
• Lack of Control: When delegating investment decisions to a money manager, clients relinquish direct control over their portfolio. This can be a drawback for investors who prefer to be more hands-on with their investments or have very specific ethical or social investing preferences that may not be fully aligned with the manager's standard offerings.
• Market Risk: Even the most skilled money managers cannot eliminate market risk. Portfolios managed by professionals are still subject to market fluctuations, economic downturns, and unforeseen events, and no manager can guarantee returns.

Money Managers vs. Financial Advisors

While the terms "money manager" and "financial advisor" are often used interchangeably, there's a key distinction rooted in their primary functions within financial services.

A money manager's core responsibility revolves around the actual buying and selling of securities to manage an investment portfolio. They are deeply involved in asset allocation, security analysis, and trading.

In contrast, a financial advisor offers a broader range of services. While investment advice is often a component of their role, a financial advisor also addresses areas such as retirement planning, tax strategies, insurance, and estate planning. They help clients create a comprehensive financial roadmap, which may or may not include directly managing their investments. Many financial advisors may outsource the actual money management to third-party money managers or recommend specific investment products.

FAQs

What qualifications do money managers typically need?

Money managers are typically required to pass qualifying exams and register with regulatory bodies. In the U.S., many register with the Securities and Exchange Commission (SEC) under the Investment Advisers Act of 1940 if they manage over a certain threshold of assets, or with state regulators if below that threshold³. They often hold certifications like the Chartered Financial Analyst (CFA) designation, which demonstrates expertise in investment management.

How are money managers compensated?

Money managers are primarily compensated through fees, most commonly a percentage of the assets under management (AUM). For example, a manager might charge 1% of the AUM annually. Some managers, particularly those managing hedge funds, may also charge performance fees, which are a percentage of the profits generated above a certain benchmark. Other fee structures can include hourly rates or fixed fees, though these are less common for direct portfolio management.

Can I lose money with a money manager?

Yes, it is possible to lose money even when investing with a money manager. Money managers aim to grow and preserve capital, but they cannot eliminate market risk. The value of investments can fluctuate due to economic conditions, market trends, or company-specific factors. Money managers are not allowed to promise or guarantee specific returns.

What is "assets under management" (AUM)?

Assets under management (AUM) refers to the total market value of all financial assets that a money manager or investment firm manages on behalf of its clients². AUM is a key metric for evaluating the size and influence of a money management firm and often dictates the fee structure applied to client accounts. As of late 2023, global AUM for the largest managers exceeded $128 trillion¹.

How do I choose a suitable money manager?

Choosing a suitable money manager involves evaluating several factors: their investment philosophy and how it aligns with your goals, their fee structure, their historical performance (understanding that past performance does not guarantee future results), their regulatory compliance and any disciplinary history, and their client service approach. It's also important to consider their fiduciary duty, meaning they are legally obligated to act in your best interest.