Investment management
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.
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).
Useful WikJob links
[[Investment Managers and Portfolio Structures]]
Investment Management vs. Investment Banking
There’s no doubt that downward cycles in the global economy can disrupt fees that involve performance incentives, especially when the downswing is as severe and systemic as the recent crisis. Plus, when investors get spooked there may be fewer new assets to manage. But generally speaking the asset management business is lesscyclical than its financial cousins like investment banking.
Consider the hallmarks of investment banking: IPOs and mergers and acquisitions. When times are good, there’s a lot of money to be made in these activities. But when the deal pipeline slows down because of economic conditions, transaction fees simply don’t materialise. That means bankers get laid off, or I-banks freeze hiring, or both. These swings in fortune can happen very quickly, as we saw in 2007. During the first half of the year deals were booming and I-bankers were flush with cash, perks and bonuses. Then the credit crunch hit, and pink slips flew: over 225,000 financial services professionals lost their jobs in 2008, many of them investment bankers. The I-bankers who remained were faced with significantly smaller paycheques. According to London’s Centre for Economics and Business Research (CEBR), bankers in the City received a total of £8.8 billion in bonuses at the end of 2006. That figure fell to approximately £3.6 billion at the close of 2008, and CEBR predicts it will drop again, to £2.8 billion, for 2009.
By contrast, analysts and associates at investment management firms benefit from the fact that assets are always being invested, even in bad times. Investment management firms also tend to have a diverse client base that includes pension funds, insurance companies, banks, mutual funds and highnet-worth individuals, and portfolio managers can make money for their clients in a number of ways.Obviously, they want to play the market and make returns, by investing in a lucrative IPO, for example. But even if there are fewer IPOs taking place, managers can still make gains with smart plays in other asset classes, or by investing existing capital in various portfolios. A bear market may force portfolio managers to be extra-cautious in their investments, but they will always have choices. Meanwhile, their I-banker friends will either have capital-raising and advisory assignments ... or they won’t.
As one staffer in the operational department of a major asset management firm says, “Investment bankers normally only have a single-stream of customers and are doing the same thing day in day out. Also, the sell-side is driven by the requirements of the buy-side.” The link between investment bankers to investment managers might be symbiotic, to some extent, but those managing money have more options to guarantee their survival.Introduction
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The investment management industry tends to have a work load that varies. Working at a mutual or hedge fund typically means hours dictated by when the market opens and closes, and in many cases balances out to a fairly normal schedule. Land a job at a private equity firm and the story may differ; the salary is bigger, but the work hours are longer. Smaller private equity players still require their staff to work 60 to 70 hours a week. Still, they don't compare to the hours put in by investment bankers. Investment bankers are known for working extremely long hours—around 90 to 100 per week on average (or about 16 hours per day during a six-day workweek and 14 hours per day during a sevenday workweek).Hours
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Graduates who join asset managers straight out of university may initially take home less than their investment banking counterparts. The average starting salary of graduates in the asset management industry is around £30,000 to £35,000, according to one HR manager at an investment management firm, whereas graduates in investment banking start on a median of £35,000 to £40,000. However, you move up the pay hierarchy with bigger leaps at asset management firms, and often in less stressful environments. And it’s important to keep in mind that compensation and pay structure may differ from company to company; one investment management insider said that the pay and bonus offered at her firm was exactly the same as what was offered at an investment bank where she’d previously worked.Pay
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Investment Managers and Portfolio Structures
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)...Asset allocation
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.Long-term returns
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.Diversification
Buy Side vs Sell Side
Jobs On The Buy Side
• Portfolio managers who invest money on behalf of their clients
• Research analysts who provide portfolio managers with potential investment recommendations
and, in some cases, invest money in their respective sectors
• Account and product managers who manage client relationships and distribute the investment
products to individual and institutional investors
• Operation staff who carry out back-office roles, ranging from systems developers to risk analysts
When beginning your career on the buy-side, you typically will start as an analyst, or in one of these
aforementioned four areas.
Jobs on the Sell Side
There are two primary career paths for recent undergraduates in a sell-side firm: sales and trading, and investment banking. Both equity and fixed income research typically fall under the sales and trading umbrella, although some banks break out the research entirely on their own.
The primary position for those interested in investment management on the sell-side will be in either equity or fixed income research. Research professionals analyse company and industry statistics, predict earnings and cash flows, determine appropriate valuations and recommend investments to buy-side clients. Typically, graduates work as junior analysts for senior industry research analysts. Individuals hired from business schools, however, generally start as research analysts working directlywith the senior analyst. Sell-side research associates spend the majority of their day gathering industry data, populating investment models and preparing the foundations of company and industry reports. Over time, they typically garner more responsibilities, such as attending industry events and investor presentations, and running various financial analyses.Positions in sell-side research
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Sell-side research associate-analysts build investment models, assist in generating investment recommendations, write company and industry reports, and help to communicate recommendations to buy-side clients. Over time, the associate-analyst may often pick up coverage of additional stocks (often small or mid cap), using the analyst as a mentor.
Investment banking professionals assist companies in raising capital and exploring various financial alternatives. (Professionals in I-banking are called analysts if they are university graduates and associates if they are MBA graduates.) Some of the most common transactions that investment bankers work on are initial public offerings (IPOs) and company mergers and acquisitions (M&A). Typically, analysts and associates work between 80 and 100 hours per week preparing presentations and financial models for banking clients. Undergraduate students have the opportunity to enter into “analyst” training programmes whereas MBA graduates have the opportunity to enter into “associate” training programmes. After training they are placed into either industry groups, such as media,
financial services, or industrials, or into product groups, such as M&A, equity capital markets or debt capital markets.Positions in investment banking
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Investment Styles
The Drive For Diversification
Typically, investors (whether individual or institutional) allocate various portions of their assets to different investment styles. Rather than focus all their assets on one asset class, or one investment style, investors spread their investments over a variety of products and classes. The style of a portfolio,such as a mutual fund, is clearly indicated through its name and marketing materials so investors know what to expect from it. Adherence to the styles marketed is more heavily scrutinised by institutional and pension fund customers than by mutual fund customers. Institutional investors monitor their funds every day to make sure that the asset manager is investing as they said they
would. Imagine the overall wealth of an individual or institution as a pie. Think of each slice as investing in a different portfolio of securities; this is what’s called diversification.
Types of Security
Stocks
Equity portfolios invest in the stock of public companies. This means the portfolios are purchasing a share of the company—they are actually becoming owners of the company and, as a result, directly benefit if it performs well. Equity investors may reap these benefits in the form of dividends (the distribution of profits to shareholders), or simply through an increase in share price.
Bonds
Fixed income portfolios invest in bonds, a different type of security than stocks. Bonds can be thought of as loans issued by such organisations as companies or municipalities: they are often referred to as debt. Like loans, bonds have a fixed term of existence and pay a fixed rate of return. For example, a company may issue a five-year bond that pays a 7 per cent annual return. This company is then under a contractual obligation to pay this interest amount to bondholders, as well as return the original amount at the end of the term.
Although bondholders aren’t “owners” of the bond issuer in the same way that equity shareholders are, they maintain a claim on its assets as creditors. If a company cannot pay its bond obligations, bondholders may take control of its assets (in the same way that a bank can repossess your car if you don’t make your payments). Lenders further up the capital structure normally find it easier to redeem assets of the company. Institutions such as banks will normally be reimbursed before individual bond holders.
Derivatives
In recent years derivatives have become a major part of the European asset management industry.Major asset management firms have implemented systems to enable the widespread use of derivatives as an investment and risk management tool. Simply put, a derivative is any financial instrument whose payoffs are derived from the value of an underlying variable at a time in the future—
hence the name. Types of derivatives include options, warrants and futures. Stock and index options are widely used by professional investors to hedge their share portfolios. Index options allow investors to gain wider exposure to the market rather than just single securities. Derivatives are also a risk management tool: depending on how they are used and how leveraged they are, they can either
increase or reduce the risk of an investment. The derivatives market received a lot of attention in 2008, most of it negative. The US government was forced to spend $85 billion bailing out global insurance giant American International Group (AIG), which was crippled by losses on credit default swaps (CDSs), a type of derivative.
Risk Characteristics of Investments
Types of stocks and their risk profiles
Most equity portfolios are classified in two ways:
• By size, or market capitalisation, of the companies whose stocks are invested in by the portfolios
• By risk profile or valuation of the stocks
Market capitalisation of investments
The market capitalisation (also known as “market cap”) of a company refers to the company’s total value according to the stock market. It is the product of the company’s current stock price and the number of shares outstanding. For example, a company with a stock price of £10 and 10 million outstanding shares has a market cap of £100 million.
Companies (and their stocks) are usually categorised as small-, mid- or large capitalisation. Most equity portfolios focus on one type, but some invest across market capitalisation. Examples of large cap companies can be found on the FTSE 100 index, whereas indices such as the FTSE Small Cap Index or the Hoare Govett Smaller Companies Index list the small caps. Whereas there is no real answer and definitions vary, small capitalisation typically means any company worth less than £1 billion. Mid-caps usually have a market value in the £250 million to £2 billionrange, whereas large-caps can be valued anywhere from £2 billion upwards.
As would be expected, large capitalisation stocks primarily constitute well-established companies with long standing track records. Although this is generally true, the tremendous growth of new technology companies over the past decade has propelled many fledgling companies into the ranks of large-capitalisation. For instance, Google has a market-capitalisation of around $149 billion and is one of the largest companies in the world. In the same way, small and medium capitalisation stocks not only include new or underrecognised companies, but also sometimes include established firms that have struggled recently and have seen their market caps fall. Recently, fund investing in new capitalisation categories has emerged: for example, the “micro-cap” (under £150 million) and “mega-cap” (over £35 billion) funds, each with the stated objective of investing in very small or very large companies.
Risk profiles: “value” vs. “growth” investing
Equity portfolios invest in either “value” or “growth” stocks. These terms are also tied in with expected risk: a “growth” stock can provide higher returns and more risk. There are many ways that investors define these styles, but most explanations focus on valuation. Value stocks can be characterised as relatively well-established, high-dividend paying companies with low price-to-earnings and price-tobook
ratios. Essentially, they are “diamonds in the rough” that typically have undervalued assets and earnings potential.
Growth stocks (or “glamour” stocks) have the potential to expand at rates that exceed their respective industries or market. These companies have above average revenue and earnings growth and their stocks trade at high price-to-earnings and price-to-book ratios. Technology companies such as Google and Apple are good examples of traditional growth stocks.
Many variations of growth and value portfolios exist in the marketplace today. For instance, “aggressive growth” portfolios invest in companies that are growing rapidly through innovation or new industry developments. These investments are relatively speculative and offer higher returns with higher risk. Many biotechnology companies and new internet stocks in the late-1990s would have been classified as aggressive growth. Another classification is a “core stock” portfolio, which is a middle ground that blends investment in both growth and value stocks.
Types of Bonds and Their Risk Profiles
• Government and supranational bonds
• Investment-grade corporate bonds
• High-yield corporate bonds
• Yearlings
Government bond portfolios invest in the debt issues from national treasuries or other government
agencies. These investments tend to have low risk and low returns because of the financial stability
of national governments. In the UK, bonds are also known as gilts: this comes from the bonds being
very low risk, or “gilt-edged”. Supranational bonds are issued by institutions such as the European
Investment Bank (EIB) and the World Bank. As with government bonds, they have very low risk.
Investment-grade corporate bond portfolios invest in the debt issued by companies with high credit
standings.
These credit ratings are issued by rating companies like Standard & Poor’s. They rate
debt based on the likelihood that a company will meet the interest obligations of the debt. The returns
and risks of these investments vary along this rating spectrum. Many corporate bond portfolios invest
in company debt that ranges the entire continuum of high-grade debt.
In contrast to investment grade debt, high-yield corporate debt, also called “junk bonds”, is the debt
issued by smaller, unproven, or high-risk companies. Consequently, the risk and expected rates of
return are higher. (Junk, or high-yield, is defined as a bond with a Standard & Poor's ratings below BBB.
Yearlings invest in the debt issued by local authorities and agencies, such as public school systems. The
favourable tax treatment on these types of investments makes them a favourite of tax-sensitive investors.
Yields also tend to be higher than for central government bonds as the risk is considered greater.
Other types of bonds include index-linked bonds. The capital redemption of this type of bond is linked
to the rate of inflation. As a result, index-linked bonds are more popular in times of high inflation.
Convertible bonds are also quite popular with investors. These bonds can be exchanged for shares
or other securities, usually with the company that issued the bond.
Investment managers also manage bond portfolios that mix together the different types of bonds.
Indeed, hybrids of all kinds exist. Typically, though, if you have a lot of money, a better way to diversify
is to invest in a fund made up of one type of bond. If, for example, you’ve got £100 million to invest,
you’re likely to give £10 million to the best yearling fund manager, £10 million to the best corporate
bond fund manager, etc., rather than invest all $100 million in a hybrid.
Alpha vs Exotic Beta
Asset managers used to claim all returns were down to them. But indexes have changed that. Fund
managers should always be outperforming indexes. Beta is, simply, the amount of return that can be
explained by factors such as rising indexes or strong economic growth. The alpha, which all managers
search for, is the bit of return that cannot be attributed to outside factors. In essence, fund managers
see the alpha as their brilliance. Managers in traditionally “higher risk” funds, such as hedge funds,
claim to always obtain the alpha. The search for the alpha returns has led to the “exotic beta”, of which
there are two types. One “exotic beta” refers to investment in “exotic” assets such as shipping freight,
wine and even footballers using normal strategies. Another is applying “exotic” strategies to “normal”
securities with new trading styles to find new arbitrages in traditional markets.
Risk Analytics
Risk in the economy
Financial risk can never be eliminated completely, so much of an investment manager’s job focusses
on measuring, monitoring and minimising it. Broadly speaking, there are two types of economic risk
that can impact an investment manager’s work: systemic risks and specific risks. The former are
threats to the entire financial system or large chunks of it; the latter are market risks that affect
individual portfolios or individual assets in portfolios. Specific risks include capital risk, which is the
loss of the initial investment, and currency risk, which is a loss precipitated by exchange rate swings.
British investors who held lots of dollar-denominated assets, for instance, lost portfolio value when the
dollar declined in 2008. Legal risk and compliance risk may not seem like financial concerns at first,
but they’re still risks that can damage asset value—picture a company whose stock plummets because
the CEO is arrested for breaking the law.
No matter how conscientious investment managers are, however, they cannot protect portfolios from
systemic risk. For the most part, it’s up to central banks and governments to guard the financial system
against collapse, a task that has become increasingly complicated. Systemic problems can cause
widespread damage through a domino effect, as one financial institution’s woes trigger a catastrophe
for other others halfway around the globe, touching off waves of investor panic. Systemic risks rise as
financial institutions become more interconnected and as they become more highly leveraged.
The subprime mortgage crisis offers a recent example of systemic risks. When the US housing bubble
burst and people began defaulting on their home loans, mortgages and mortgage-backed securities
(especially those built on subprime mortgages) shed value, leaving many overleveraged institutions
without the capacity to cover their losses. Complex instruments like credit default swaps that were
intended to protect banks from the risk of creditors’ defaulting actually compounded the problem, as
institutions that were supposed to pay this insurance lacked resources to do so.
This phenomenon,
known as counterparty risk, meant that everyone holding such contracts feared that the party on the
other side of the contract might be on the verge of default. The result? Global panic, frozen credit
markets, loss of liquidity and, ultimately, pricey bailout plans.
Portfolio Construction
All portfolios, whether stocks or bonds, are compared to benchmarks to gauge their performance;
indices or peer group statistics are used to monitor each fund’s success. Standard indices for equity
portfolios include the FTSE 100 and All-Share Index. For bonds, popular benchmarks include the UK
Gilts 2 Year. These indices are composed of representative stocks or bonds. They function as a general
barometer for the performance of a particular portion of the market they are designed to measure.
As composites, the indices can be thought of as similar to polls: a polling firm that seeks to understand
what a certain population thinks about an issue will ask representatives of that cross-section of the
population. Similarly, a stock or bond benchmark that seeks to measure a certain portion of the market
will simply compile the values of representative stocks or bonds.
Portfolio construction refers to the manner in which securities are selected and then weighted in the
overall mix of the portfolio with respect to these indices. Portfolio construction is a fairly recent
phenomenon, and has been driven by the advent of modern portfolio theory (MPT).
How is This Relevant to My Job Search?
If you are beginning your job search in the investment management industry, you need to begin
thinking about what investment styles strike you as most interesting. Although many of the styles
overlap, and being overly specific might limit you, understanding the differences can help in targeting
companies you want to work for.
Don’t be concerned that your choice of employer will pigeonhole you. Whereas you should try to find
a position with a firm whose investment style most interests you, you can always switch gears into a
different investment style after you have some experience. Initially, it is best to be in an environment
where you can learn about investing in general.
However, when you target your career search, you should be informed of the firm’s particular
investment style. Although large asset managers invest across a multitude of styles, other firms may
only specialise in one style. It is always important to have knowledge of these nuances. This will
definitely benefit you during interviews, because passion and knowledge about the industry always wins
valuable points with recruiters.
Research Roles: Traditional vs. Alternative Asset Managers
The Clients of Asset Managers
Retail Funds
There are some interesting
differences between the European and American mutual fund markets: according to The Economist,
there are over 26,000 mutual funds in Europe, and just 8,000 in the United States. However,
American mutual funds tend to be much larger than their European counterparts—the US mutual
fund industry has almost $10 trillion in assets under management, while European mutual funds
manage just under $6 trillion.
Retail funds are structured so that each investor owns a share of the fund; investors do not maintain
separate portfolios, but rather pool their money together. Their appeal can generally be attributed to
the ease of investing through them and the relatively small contribution needed to diversify
investments. In the past 10 years retail funds have become an increasingly integral part of the asset
management industry. They generally constitute a large portion of a firm’s assets under management
(AUM) and ultimate profitability.
There are two ways that retail funds are sold to the individuals that invest in them: through third-party
brokers or “fund supermarkets” and direct to customer. The size and breadth of the asset
management company typically dictates whether one or two methods are used.
Institutional Investors
Institutional investors are very different from their mutual fund brethren. These clients represent large
pools of assets for government pension funds, corporate pension funds, endowments and foundations.
Institutional investors are also referred to in the industry as “sophisticated investors” and are usually
represented by corporate treasurers, CFOs and pension boards. Estimates suggest they represent
almost three-quarters of the assets under management (AUM) in Europe. In the UK, about 79 per
cent of assets are managed on behalf of institutional investors, primarily corporate pension funds and
insurance companies.
High-Net-Worth
Geographically speaking, high-net-worth individuals in the United States, Japan and Germany made
up 54 per cent of the global HNW population in 2008, and for the first time, China’s HNW population
became the world’s fourth-largest, beating the UK.
What is high net worth?
What is a high-net-worth investor? Definitions differ, but a good rule of thumb is an individual with
minimum investable assets of £10 million. These investors are typically taxable (like retail funds but
unlike institutional investors), but their portfolio accounts are managed separately (unlike retail funds,
but like institutional investors).
High-net-worth individuals also require high levels of client service as they may not necessarily be the
savviest investors. Those considering entering this side of the market should be prepared to be as
interested in client relationship management as in portfolio management, although the full force of
client relations is borne not by a portfolio manager but a sell-side salesperson in a firm’s private client
services (PCS) or private wealth management (PWM) division.
In reality there are two classes of high-net-worth clients: those in the £1 million and above range and
those in the £250,000 to £1 million range. Those with £1 million and above to invest receive
customised and separately managed portfolios, whereas those in the lower bracket do not. This
second class does receive much more personal attention from their PCS salesperson than they would
from a traditional retail broker. But, unlike the £1 million and above range, this second group’s portfolio
management is derived from cookie cutter products and strategies. Still, this service is performed by
a portfolio manager devoted to high-net-