What is investment management? If a firm is offering investment management as one of their services, how does that differ from other kinds of investment advice? Unfortunately, the financial industry doesn’t make it easy to make these distinctions. Terms like financial advisor, portfolio manager, financial planner, investment manager, etc., are often used by different firms to describe the same service. However, at its core, a firm that offers true investment management is going to have some common features. There are also some elements that not all firms offer, but that we consider best practices. Here are some thoughts on what investment management is, how it might benefit you, and what the trade-offs might be vs. other kinds of investment advice.
What is investment management?
Investment management is a service that involves dynamically and proactively managing your assets on a discretionary basis.
There are a few key elements that distinguish investment management from other kinds of investment advice.
- Discretionary management: A firm offering investment management will have “discretion”, which is the legal authority to make trades in your account on your behalf. Generally speaking, they won’t ask for your approval before making portfolio changes.
- Proactive:The team managing your assets are looking for market opportunities, changing risks, etc., and adjusting your portfolio accordingly. They aren’t waiting for periodic meetings and/or for you to suggest changes.
- Dynamic: Investment management portfolios aren’t static. Some managers trade more actively than others, but all are making portfolio changes as risks and opportunities evolve.
- Professionally managed: The person or team of people managing your money are full-time investment professionals. Those individuals typically aren’t your advisor or financial planner, but are solely focused on managing investments.
There are many types of firms that offer investment management:
- Mutual fund companies: These firms offer funds covering various asset classes. You select the funds you want, and the firm manages your money inside of those funds. Examples include Capital Group (American Funds), T. Rowe Price, or TIAA/Nuveen.
- Asset managers: This is a firm that is mostly focused on investing, often specializing in a particular asset class. For example, picking stocks on your behalf. They may offer some limited advice outside of investing. Fisher Investments is a well-known example of a firm that is primarily an asset manager.
- Integrated firms: Some firms offer investment management embedded within a broader set of services, such as financial planning. Exactly how integrated investment management is with planning and/or other services varies widely by firm. The fee arrangements also vary significantly. Facet is one such example of an integrated investment manager.
Most firms that offer investment management - including Facet - are organized as Registered Investment Advisors or RIAs. This means they are legally required to act as a fiduciary, meaning they must make recommendations in your best interest according to fiduciary standards.
Why pick investment management vs. other types of advisors?
Unlike some advisors who may rely on static models or make reactive decisions, firms offering investment management will have a proactive discretionary approach dedicated specifically to optimizing and growing your portfolio.
With a firm that provides investment management, you are effectively hiring a full-time expert on financial markets. They will be thinking proactively about what to own in your portfolio given risks and opportunities in today’s economy, or at least, the asset class that the manager covers. You can have confidence that at any given moment, your portfolio is positioned given the manager’s current best thinking. By no means does that assure outperformance or beating the market. But it does mean your portfolio is evolving along with the economy, and is being guided by experienced professionals.
Most other kinds of advisors select investments based on either a static or non-discretionary approach:
- Static portfolios: This is where your advisor puts your portfolio in a set of funds with a target weighting that more or less never changes. They generally rebalance back to that target regularly. There is some appeal to a “set it and forget it” portfolio. However, will today’s portfolio decisions hold up in 5 or 10 years? Think back on how much the world has changed in the last 10 years. You may want a portfolio that adapts as the world evolves. In a sense, a static portfolio is betting that the world remains static too.
- Non-discretionary: In this case, your advisor may suggest portfolio changes to you, but you must approve each decision. On the plus side, this affords you a certain amount of control. However, it tends to result in reactive portfolio decisions. Your advisor likely has a large book of clients. You may not be their first call when there is a new investment idea. In addition, your advisor has a wide range of responsibilities outside of just investing: servicing clients, finding new clients, paperwork, etc. Investing is not always their primary focus.
What are the benefits of professional investment management vs. investing on my own?
By having your money professionally managed, you gain access to professional expertise and advanced technology for tasks like tax monitoring and portfolio rebalancing, though this often requires delegating day-to-day control of your portfolio.
As we discussed previously, utilizing professional investment management means you’ll have a team of investment experts watching over your portfolio and proactively making adjustments. While many individual investors enjoy managing their own portfolio, very few have the years of experience and training that pros have. Moreover, you are unlikely to be able to dedicate the kind of time necessary to follow the market, perform investment due diligence, and analyze performance the way professionals do.
Firms offering investment management also generally have teams and advanced tech that handle things like portfolio monitoring, rebalancing, tax-loss harvesting, and routine trading.
The trade-off is control. If you have been managing money yourself, you may have gotten accustomed to having control over your portfolio decisions. It can feel like a big leap to turn that over to someone else.
For many individuals, it becomes a matter of whether they would prefer that control or prefer to have a pro watching over their money.
What are different kinds of fees charged for investment management?
Firms may charge fees for investment management in several ways, including Assets Under Management (AUM) fees, through revenue sharing and proprietary products. Or, the firm may offer investment management as part of a broader set of services under a single fee. It is important to understand a firm's fee structure before hiring them.
There are several ways in which firms might earn revenue from investment management. A firm may utilize one or more of these sources.
- Assets Under Management (AUM) fees: In this arrangement, you agree to pay the manager some percentage of your assets each year. This is by far the most common form of fees charged by investment firms. For example, if you have $1 million in assets with that manager and the AUM fee is 1%, you would be paying $10,000 in fees. Note that because the fee is a percentage, as your assets grow, so will this fee.
- Proprietary products: This would be where an investment manager recommends a strategy or other product where the firm also gets a fee. A common example would be a mutual fund managed by that same firm.
- Revenue sharing: Sometimes fund companies or other service providers agree to share some amount of their revenue with an advisor. This may include the money market fund used to hold cash. While these arrangements need to be disclosed, it may take some effort to find that disclosure.
- Bank sweep programs: Advisors that are part of a bank or brokerage firm may also make money by lending your money similar to a commercial bank. This is also something that needs to be disclosed.
- Comprehensive service fees: In this case, the firm charges a single fee to cover the various services offered. For example, Facet charges a flat fee to cover financial planning, investment management, and other services. There is no incremental cost or requirement to utilize investment management. One benefit of this flat fee arrangement is that as your assets grow, your fee does not.
A given firm may use one or more of the examples above as compensation for managing your money. None of these are automatically disqualifying, but you should be fully aware of what fees will be charged. You may also want to give some thought as to how the firm charges fees impacts their incentives to select certain investments.
What should I look for when comparing different firms offering investment management?
When vetting a firm’s investment management service, you should look closely at their investment philosophy, fee structure, past performance relative to benchmarks, and whether their incentives align with your financial goals.
Here are the key factors to put on your checklist when vetting a firm offering investment management:
- Identify the portfolio managers: The firm should be able to identify an individual or team who will be involved in managing your portfolio. You should be able to check that these individuals have the experience and training that you would expect. Generally speaking, the person you talk to day-to-day probably isn’t part of that team. If the firm is truly offering investment management, there should be full-time, dedicated people working exclusively on investments.
- Review their philosophy and process: Can the manager articulate a clear approach to managing money? Beware of a process that boils down to “we just pick great stocks.” Successful individual stock selection is notoriously difficult to sustain year after year.
- Examine past performance against benchmarks: You should be able to see performance history for money managed by your team within the firm in question, and it should be compared to a sensible benchmark. Note that you shouldn’t just hire the investment manager with the best performance. As the saying goes, past performance is no guarantee of future results. However, asking for historic performance can be a good test of how transparent the firm is.
- Understand the “why” behind the performance: It isn’t enough to just know that a strategy has performed reasonably well in the past. You want to spend some time considering why they performed well. One good way to check is to ask for published commentary on investment performance. This also helps you tell how transparent the firm is with their clients. If they don’t have any performance commentary to share with you, it probably means you also won’t be getting any such thing as a client.
- Check for aligned incentives: Does the way the firm charges fees create any conflicts? Would making certain recommendations result in more revenue for the firm? You should at least know about any possible conflicts before selecting a manager. Any potential conflict should be disclosed to you.
- Consider the whole package of services: Most people need more in-depth financial advice than just investment management. This includes things like tax advice, estate planning, retirement planning, insurance, etc. Some people prefer to hire separate advisors to help with different aspects of their financial life, but this can get expensive. Determine what services you might need or want, and consider finding a firm that can cover as many of those services as possible.
Is professional investment management right for my situation?
The answer depends on what you want. Professional investment management may give you a more sophisticated, proactive approach to investing than other kinds of advisors and/or self-management. This does come at a cost of giving up a certain amount of control. However, it could help you gain more confidence in your investment strategy, particularly if it can be tied with a comprehensive financial plan. It may also free you up from the time and stress of worrying about the ups and downs of markets on your own.
