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Author: Richard Adams
Investment Management
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Investment management is the professional management of various securities (shares,
bonds etc) 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) .
The term asset management is often used to refer to the investment management of
collective investments, 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
The provision of 'investment management services' includes elements of financial
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 advisor in the U.S.) refers to both a firm that provides
investment management services and an individual(s) who directs 'fund management'


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).
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;
Evidence suggests that size of an investment firm correlates inversely with fund
performance, i.e., the smaller the firm the better the chance of good performance.
Analysts who generate above-average returns often become sufficiently wealthy
that they eschew corporate employment in favor of managing their personal
The most successful investment firms in the world have probably been those that have
been separated physically and psychologically from banks and insurance companies. That
is, the best performance and also the most dynamic business strategies (in this field) have
generally come from independent investment management firms.
Representing the owners of shares
Institutions often control huge shareholdings. In most cases they are acting as agents
(intermediaries between owners of the shares and the companies owned) 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 vote the entire holding as directed by
the majority of votes cast, split vote (where this is allowed) according to the proportions
of the vote or respect the abstainers and only vote the respondents holding.
The price signals generated by large active managers holding or not holding the stock
contribute to management change.
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 Barclays Global Investors and Vanguard--advocate simply owning
every company, reducing the incentive to influence management teams.
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
Size of the global fund management industry
Assets of the global fund management industry increased for the third year running in
2006 to reach a record $55.0 trillion. This was up 10% on the previous year and 54% on
2002. Growth during the past three years has been due to an increase in capital inflows
and strong performance of equity markets.
Pension assets totalled $20.6 trillion in 2005, with a further $16.6 trillion invested in
insurance funds and $17.8 trillion in mutual funds. Merrill Lynch also estimates the value
of private wealth at $33.3 trillion of which about a third was incorporated in other forms
of conventional investment management.
The US was by far the largest source of funds under management in 2005 with 48% of
the world total. It was followed by Japan with 11% and the UK with 7%. The Asia-
Pacific region has shown the strongest growth in recent years. Countries such as China
and India offer huge potential and many companies are showing an increased focus in
this region.
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, does the manager buy growth or value shares (and why), does he believe
in market timing (and on what evidence), does he rely on external research or
does he 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, which universe of assets is explored before particular assets are chosen
as suitable investments; how does the manager decide what to buy and when; how
does the manager decide what to sell and when; who takes the decisions and are
they taken by committee; what controls are in place to ensure that a rogue fund
(one very different from others and from what is intended) cannot arise;
People refer to the staff, especially the fund managers. The question is 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), then arguably the performance record is
completely unrelated to the existing team (of fund managers).
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.
Asset allocation
The different asset classes 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 monies 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).
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, more risky than cash.


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 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.
Investment styles
There are a range of different styles of fund management that the institution can
implement. For example, growth, value, market neutral, small capitalization, 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.
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) 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, industrywide, there is a serious pre-occupation 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 represents the benefit to the investor, but investors tax positions vary. Before tax
measurement can mislead, especially in regimens that tax realised capital gains (and not


unrealised). A successful active manager, measured before tax, can thus produce a
miserable after tax result. One possible solution is to report the after-tax position of some
standard tax-payer.
Absolute versus relative performance
In the USA and the UK, two of the world's most sophisticated fund management markets,
the tradition is for institutions to manage client money relative to benchmarks. For
example, an institution believes it has done well if it has generated a return of 5% when
the average manager generates a 4% return.
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
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
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 a three-factor model to describe portfolio normal returns. 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.
Education or Certification
Increasingly, international business schools are incorporating the subject into their course
outlines and some have formulated the title of 'Investment Management' conferred as
specialist bachelors degrees. (i.e. Cass Business School, London). Due to global cross-
recognition agreements with the 2 major accrediting agencies AACSB and ACBSP which
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 B.S. in business, finance, or
economics. A graduate degree or an investment certification such as Chartered Financial
Analyst (CFA) or Chartered Alternative Investment Analyst (CAIA) may be required to
move up in the ranks of investment management
(2006-08-01). "Fund Management: City Business Series" (PDF). International Financial
Services, London. Retrieved on 2007-02-01. David Swensen, "Pioneering Portfolio
Management: An Unconventional Approach to Institutional Investment," New York, NY:
The Free Press, May 2000.

Rex A. Sinquefeld and Roger G. Ibbotson, Annual Yearbooks dealing with Stocks,
Bonds, Bills and Inflation (relevant to long term returns to US financial assets).

Harry Markowitz, Portfolio Selection: Efficient Diversification of Investments, New
Haven: Yale University Press

S.N. Levine, The Investment Managers Handbook, Irwin Professional Publishing (May
1980), ISBN 0-87094-207-7.

V. Le Sourd, 2007, Performance Measurement for Traditional Investment � Literature
Survey, EDHEC Publication.




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