Investment management

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"Asset management" redirects here. For other uses, see Asset management (disambiguation).

Investment management is the professional management of various securities (shares, bonds and

other securities) and assets (e.g., real estate), to meet specified investment goals for the benefit of
the investors. Investors may be institutions (insurance companies, pension funds, corporations etc.)
or private investors (both directly via investment contracts and more commonly via collective
investment schemes e.g. mutual funds or exchange-traded funds) .

The term asset management is often used to refer to the investment management of collective
investments, (not necessarily) whilst the more generic fund management may refer to all forms of
institutional investment as well as investment management for private investors. Investment
managers who specialize in advisory or discretionary management on behalf of (normally wealthy)
private investors may often refer to their services as wealth management or portfolio management
often within the context of so-called "private banking".

The provision of 'investment management services' includes elements of financial statement

analysis, asset selection, stock selection, plan implementation and ongoing monitoring of
investments. Investment management is a large and important global industry in its own right
responsible for caretaking of trillions of dollars, euro, pounds and yen. Coming under the remit
of financial services many of the world's largest companies are at least in part investment managers
and employ millions of staff and create billions in revenue.

Fund manager (or investment adviser in the United States) refers to both a firm that provides
investment management services and an individual who directs fund management decisions.

Industry scope
The business of investment management has several facets, including the employment of
professional fund managers, research (of individual assets and asset classes), dealing, settlement,
marketing, internal auditing, and the preparation of reports for clients. The largest financial fund
managers are firms that exhibit all the complexity their size demands. Apart from the people who
bring in the money (marketers) and the people who direct investment (the fund managers), there are
compliance staff (to ensure accord with legislative and regulatory constraints), internal auditors of
various kinds (to examine internal systems and controls), financial controllers (to account for the
institutions' own money and costs), computer experts, and "back office" employees (to track and
record transactions and fund valuations for up to thousands of clients per institution).
[edit]Key problems of running such businesses
Key problems include:

 revenue is directly linked to market valuations, so a major fall in asset prices causes a
precipitous decline in revenues relative to costs;
 above-average fund performance is difficult to sustain, and clients may not be patient during
times of poor performance;
 successful fund managers are expensive and may be headhunted by competitors;
 above-average fund performance appears to be dependent on the unique skills of the fund
manager; however, clients are loath to stake their investments on the ability of a few individuals-
they would rather see firm-wide success, attributable to a single philosophy and internal
discipline;
 analysts who generate above-average returns often become sufficiently wealthy that they
avoid corporate employment in favour of managing their personal portfolios.
[edit]Representing the owners of shares
Institutions often control huge shareholdings. In most cases they are acting as fiduciary agents
rather than principals (direct owners). The owners of shares theoretically have great power to alter
the companies they own via the voting rights the shares carry and the consequent ability to pressure
managements, and if necessary out-vote them at annual and other meetings.

In practice, the ultimate owners of shares often do not exercise the power they collectively hold
(because the owners are many, each with small holdings); financial institutions (as agents)
sometimes do. There is a general belief that shareholders - in this case, the institutions acting as
agents—could and should exercise more active influence over the companies in which they hold
shares (e.g., to hold managers to account, to ensure Boards effective functioning). Such action
would add a pressure group to those (the regulators and the Board) overseeing management.

However there is the problem of how the institution should exercise this power. One way is for the
institution to decide, the other is for the institution to poll its beneficiaries. Assuming that the
institution polls, should it then: (i) Vote the entire holding as directed by the majority of votes cast?
(ii) Split the vote (where this is allowed) according to the proportions of the vote? (iii) Or respect the
abstainers and only vote the respondents' holdings?

The price signals generated by large active managers holding or not holding the stock may
contribute to management change. For example, this is the case when a large active manager sells
his position in a company, leading to (possibly) a decline in the stock price, but more importantly a
loss of confidence by the markets in the management of the company, thus precipitating changes in
the management team.

Some institutions have been more vocal and active in pursuing such matters; for instance, some
firms believe that there are investment advantages to accumulating substantial minority
shareholdings (i.e. 10% or more) and putting pressure on management to implement significant
changes in the business. In some cases, institutions with minority holdings work together to force
management change. Perhaps more frequent is the sustained pressure that large institutions bring
to bear on management teams through persuasive discourse and PR. On the other hand, some of
the largest investment managers—such as BlackRock and Vanguard—advocate simply owning
every company, reducing the incentive to influence management teams. A reason for this last
strategy is that the investment manager prefers a closer, more open and honest relationship with a
company's management team than would exist if they exercised control; allowing them to make a
better investment decision.

The national context in which shareholder representation considerations are set is variable and
important. The USA is a litigious society and shareholders use the law as a lever to pressure
management teams. In Japan it is traditional for shareholders to be low in the 'pecking order,' which
often allows management and labor to ignore the rights of the ultimate owners. Whereas US firms
generally cater to shareholders, Japanese businesses generally exhibit a stakeholder mentality, in
which they seek consensus amongst all interested parties (against a background of
strong unions and labour legislation).

[edit]Size of the global fund management industry

Conventional assets under management of the global fund management industry fell 19% in 2008,
to $61.6 trillion. Pension assets accounted for $24.0 trillion of the total, with $18.9 trillion invested in
mutual funds and $18.7 trillion in insurance funds. Together with alternative assets (sovereign wealth
funds, hedge funds, private equity funds and exchange traded funds) and funds of wealthy
individuals, assets of the global fund management industry totalled around $90 trillion at the end of
2008, a fall of 17% on the previous year. The decline in 2008 followed five successive years of
growth during which assets under management more than doubled. Falls on equity markets, poor
investment performance, reduced inflow of new funds, and investor redemptions, all contributed to
the fall in assets in 2008. The decline reported in US dollars was also exacerbated by the
strengthening of the US dollar during the year.

The US remained by far the biggest source of funds, accounting for over a half of conventional
assets under management in 2008 or over $30 trillion. The UK was the second largest centre in the
world and by far the largest in Europe with around 9% of the global total. [1]
[edit]Top ten asset-management firms
JP Morgan & Chase (2.2T) State Street Global Advisors (1.9T) Bank of America/Merrill Lynch (1.5T)
has overtaken UBS (1.4T) as the largest global wealth management firm, with Citi (1.3T) still in sight.
[2]

[edit]Philosophy, process and people

The 3-P's (Philosophy, Process and People) are often used to describe the reasons why the
manager is able to produce above average results.

 Philosophy refers to the over-arching beliefs of the investment organization. For example:

(i) Does the manager buy growth or value shares (and why)? (ii) Do they believe in market timing
(and on what evidence)? (iii) Do they rely on external research or do they employ a team of
researchers? It is helpful if any and all of such fundamental beliefs are supported by proof-
statements.
 Process refers to the way in which the overall philosophy is implemented. For example: (i)
Which universe of assets is explored before particular assets are chosen as suitable
investments? (ii) How does the manager decide what to buy and when? (iii) How does the
manager decide what to sell and when? (iv) Who takes the decisions and are they taken by
committee? (v) What controls are in place to ensure that a rogue fund (one very different from
others and from what is intended) cannot arise?
 People refers to the staff, especially the fund managers. The questions are, Who are they?
How are they selected? How old are they? Who reports to whom? How deep is the team (and do
all the members understand the philosophy and process they are supposed to be using)? And
most important of all, How long has the team been working together? This last question is vital
because whatever performance record was presented at the outset of the relationship with the
client may or may not relate to (have been produced by) a team that is still in place. If the team
has changed greatly (high staff turnover or changes to the team), then arguably the performance
record is completely unrelated to the existing team (of fund managers).
[edit]Investment managers and portfolio structures
At the heart of the investment management industry are the managers who invest and divest client
investments.

A certified company investment advisor should conduct an assessment of each client's individual
needs and risk profile. The advisor then recommends appropriate investments.

[edit]Asset allocation
The different asset class definitions are widely debated, but four common divisions
are stocks, bonds, real-estate and commodities. The exercise of allocating funds among these
assets (and among individual securities within each asset class) is what investment management
firms are paid for. Asset classes exhibit different market dynamics, and different interaction effects;
thus, the allocation of money among asset classes will have a significant effect on the performance
of the fund. Some research suggests that allocation among asset classes has more predictive power
than the choice of individual holdings in determining portfolio return. Arguably, the skill of a
successful investment manager resides in constructing the asset allocation, and separately the
individual holdings, so as to outperform certain benchmarks (e.g., the peer group of competing
funds, bond and stock indices)...

[edit]Long-term returns
It is important to look at the evidence on the long-term returns to different assets, and to holding
period returns (the returns that accrue on average over different lengths of investment). For
example, over very long holding periods (eg. 10+ years) in most countries, equities have generated
higher returns than bonds, and bonds have generated higher returns than cash. According to
financial theory, this is because equities are riskier (more volatile) than bonds which are themselves
more risky than cash.

[edit]Diversification

Against the background of the asset allocation, fund managers consider the degree
of diversification that makes sense for a given client (given its risk preferences) and construct a list
of planned holdings accordingly. The list will indicate what percentage of the fund should be invested
in each particular stock or bond. The theory of portfolio diversification was originated by Markowitz
(and many others) and effective diversification requires management of the correlation between the
asset returns and the liability returns, issues internal to the portfolio (individual holdings volatility),
and cross-correlations between the returns.

[edit]Investment styles
There are a range of different styles of fund management that the institution can implement. For
example, growth, value, market neutral, small capitalisation, indexed, etc. Each of these approaches
has its distinctive features, adherents and, in any particular financial environment, distinctive risk
characteristics. For example, there is evidence that growth styles (buying rapidly growing earnings)
are especially effective when the companies able to generate such growth are scarce; conversely,
when such growth is plentiful, then there is evidence that value styles tend to outperform the indices
particularly successfully.
[edit]Performance measurement
Fund performance is the acid test of fund management, and in the institutional context accurate
measurement is a necessity. For that purpose, institutions measure the performance of each fund
(and usually for internal purposes components of each fund) under their management, and
performance is also measured by external firms that specialize in performance measurement. The
leading performance measurement firms (e.g. Frank Russell in the USA or BI-SAM[1] in Europe)
compile aggregate industry data, e.g., showing how funds in general performed against given
indices and peer groups over various time periods.

In a typical case (let us say an equity fund), then the calculation would be made (as far as the client
is concerned) every quarter and would show a percentage change compared with the prior quarter
(e.g., +4.6% total return in US dollars). This figure would be compared with other similar funds
managed within the institution (for purposes of monitoring internal controls), with performance data
for peer group funds, and with relevant indices (where available) or tailor-made performance
benchmarks where appropriate. The specialist performance measurement firms calculate quartile
and decile data and close attention would be paid to the (percentile) ranking of any fund.

Generally speaking, it is probably appropriate for an investment firm to persuade its clients to assess
performance over longer periods (e.g., 3 to 5 years) to smooth out very short term fluctuations in
performance and the influence of the business cycle. This can be difficult however and, industry
wide, there is a serious preoccupation with short-term numbers and the effect on the relationship
with clients (and resultant business risks for the institutions).

An enduring problem is whether to measure before-tax or after-tax performance. After-tax

measurement represents the benefit to the investor, but investors' tax positions may vary. Before-tax
measurement can be misleading, especially in regimens that tax realised capital gains (and not
unrealised). It is thus possible that successful active managers (measured before tax) may produce
miserable after-tax results. One possible solution is to report the after-tax position of some standard
taxpayer.

[edit]Risk-adjusted performance measurement

Performance measurement should not be reduced to the evaluation of fund returns alone, but must
also integrate other fund elements that would be of interest to investors, such as the measure of risk
taken. Several other aspects are also part of performance measurement: evaluating if managers
have succeeded in reaching their objective, i.e. if their return was sufficiently high to reward the risks
taken; how they compare to their peers; and finally whether the portfolio management results were
due to luck or the manager’s skill. The need to answer all these questions has led to the
development of more sophisticated performance measures, many of which originate in modern
portfolio theory.

Modern portfolio theory established the quantitative link that exists between portfolio risk and return.
The Capital Asset Pricing Model (CAPM) developed by Sharpe (1964) highlighted the notion of
rewarding risk and produced the first performance indicators, be they risk-adjusted ratios (Sharpe
ratio, information ratio) or differential returns compared to benchmarks (alphas). The Sharpe ratio is
the simplest and best known performance measure. It measures the return of a portfolio in excess of
the risk-free rate, compared to the total risk of the portfolio. This measure is said to be absolute, as it
does not refer to any benchmark, avoiding drawbacks related to a poor choice of benchmark.
Meanwhile, it does not allow the separation of the performance of the market in which the portfolio is
invested from that of the manager. The information ratio is a more general form of the Sharpe ratio in
which the risk-free asset is replaced by a benchmark portfolio. This measure is relative, as it
evaluates portfolio performance in reference to a benchmark, making the result strongly dependent
on this benchmark choice.

Portfolio alpha is obtained by measuring the difference between the return of the portfolio and that of
a benchmark portfolio. This measure appears to be the only reliable performance measure to
evaluate active management. In fact, we have to distinguish between normal returns, provided by
the fair reward for portfolio exposure to different risks, and obtained through passive management,
from abnormal performance (or outperformance) due to the manager’s skill, whether through market
timing or stock picking. The first component is related to allocation and style investment choices,
which may not be under the sole control of the manager, and depends on the economic context,
while the second component is an evaluation of the success of the manager’s decisions. Only the
latter, measured by alpha, allows the evaluation of the manager’s true performance.

Portfolio normal return may be evaluated using factor models. The first model, proposed by Jensen
(1968), relies on the CAPM and explains portfolio normal returns with the market index as the only
factor. It quickly becomes clear, however, that one factor is not enough to explain the returns and
that other factors have to be considered. Multi-factor models were developed as an alternative to
the CAPM, allowing a better description of portfolio risks and an accurate evaluation of managers’
performance. For example, Fama and French (1993) have highlighted two important factors that
characterise a company's risk in addition to market risk. These factors are the book-to-market ratio
and the company's size as measured by its market capitalisation. Fama and French therefore
proposed three-factor model to describe portfolio normal returns (Fama-French three-factor model).
Carhart (1997) proposed to add momentum as a fourth factor to allow the persistence of the returns
to be taken into account. Also of interest for performance measurement is Sharpe’s (1992) style
analysis model, in which factors are style indices. This model allows a custom benchmark for each
portfolio to be developed, using the linear combination of style indices that best replicate portfolio
style allocation, and leads to an accurate evaluation of portfolio alpha.

[edit]Education or certification
Increasingly, international business schools are incorporating the subject into their course outlines
and some have formulated the title of 'Investment Management' or 'Asset Management' conferred as
specialist bachelors degrees (e.g. Cass Business School, London). Due to global cross-recognition
agreements with the 2 major accrediting agencies AACSB and ACBSPwhich accredit over 560 of
the best business school programs, the Certification of MFP Master Financial Planner Professional
from the American Academy of Financial Management is available to AACSB and ACBSP business
school graduates with finance or financial services-related concentrations. For people with
aspirations to become an investment manager, further education may be needed beyond a
bachelors in business, finance, or economics. A graduate degree or an investment qualification such
as the Chartered Financial Analystdesignation (CFA) or the Certified Financial Markets Practitioner
(CFMP) Exam by the Management Laboratory may help in having a career in investment
management.[citation needed]

There is no evidence that any particular qualification enhances the most desirable characteristic of
an investment manager, that is the ability to select investments that result in an above average (risk
weighted) long-term performance[citation needed]. The industry has a tradition of seeking out, employing
and generously rewarding such people without reference to any formal qualifications [citation needed].