Investment Management

Investment Management


When you look at the investment business, you can see there are two camps or industry groupings: there are the “big ticket” big institutional firms that work mainly with pension funds, endowments, foundations, and government agencies; a second grouping comprises the retail investment firms that work mainly with individual investors. Some will straddle both camps, but these are a minority.

Investment management companies compete in their market niche in one of several ways, broken out roughly as follows:

  • Retail Experts: Companies such as Aviva and Dreman cater to individual investors with a wide array of investment products.
  • Financial Supermarkets: Fidelity, Vanguard, and Charles Schwab service individual investors and investment advisers with a broad product mix.
  • Institutional Pure Plays: Specialist companies such as Research Affiliates and Wellington Management work with big institutional investors, family offices, and wealthy investors.
  • Off-the-Shelf Shops: Boutique firms like Federated Investors and Aberdeen service retail and institutional clients with in-house products and investment advice.
  • Smart Customizers: Firms like Black Rock and Dimensional Fund Advisors (DFA) have a full menu of customized products to offer their clients. Black Rock services wealthy individuals; DFA’s niche is investment advisers who work with individual investors.

The investment management industry is much like the broader financial services marketplace: very concentrated at the top. Think of the industry as an inverted pyramid. The very largest firms, while small in number, play a dominating role and have the biggest market share. The largest firms, by virtue of their size, are active players in nearly every corner of the investment universe—mutual funds, exchange traded funds, hedge funds, and private equity. Companies like J.P. Morgan Chase (a commercial bank), Goldman Sachs (an investment bank) and Black Rock (hedge funds, private equity, and mutual funds) are examples of deep pocket companies with plenty of clout in a broad range of investment products and services.

The consolidation trend—more money managed by fewer firms—is backed by industry data. The top 25 mutual fund complexes had 77 percent of mutual fund assets in 2017, according to the Investment Company Institute, a trade group. This was an increase of 8 percent since 2005. Recent high-profile mutual fund industry mergers include Janus Capital and Henderson, as well as Standard Life and Aberdeen Asset Management. Consolidation is also occurring in the hedge fund sector. Hedge funds with more than $1 billion in assets under management control roughly 90 percent of hedge fund assets. The largest hedge funds may, or may not, produce the best results every year, but they have enough marketing clout to pull in an outsized share of client money.

More concentration at the top reveals only part of the picture. Beyond the 25 largest firms, there are many specialist managers, each focusing on a different niche or market sector (large cap stocks, small cap stocks, investment grade bonds, etc.) The largest investment firms are, in fact, incubators for newer, start-up, advisory firms created whenever a star manager leaves the big company to start up his or her own, independently managed advisory firm.

Investment management is a complex, competitive business with many different companies working together to deliver financial services to their clients. The complexity of the business is due in part to the way mutual funds or hedge funds are structured. A mutual fund (or a hedge fund) is a company set up solely for the purpose of managing investments. It has no employees. Its only asset is the investment portfolio. All client services are contracted out to a management company.

The management company hires the people—the securities analysts, traders, and portfolio managers—who actually manage the investment portfolio and process fund purchases or redemption orders. The management company also files the fund’s registration documents with the Securities and Exchange Commission. It computes daily portfolio valuations and performs other administrative duties. Fund marketing may be handled by the management company or by an independent distributor.

Hedge funds work with another servicer, the prime broker. The prime broker, a company usually affiliated with an investment bank, is a counterpart on the other side of a hedge fund’s day-to-day trading activities, providing short-term financing and structuring derivative transactions for hedge fund managers.

The complexity of the investment industry also can be seen in the distribution channels. The big mutual fund complexes sell directly to individual investors through an in-house sales force (Fidelity Investments, T. Rowe Price), through securities broker-dealers and financial planners (Capital Group for instance) or through mutual fund supermarkets (Charles Schwab, Fidelity, T.D. Ameritrade). Smaller fund companies sell their funds directly to the public or through their connections with financial planners or broker-dealer firms such as Merrill Lynch (now a division of Bank of America) and Edward Jones. Financial planners and broker-dealer firms receive a sales commission for their efforts.

The mutual fund supermarket (or fund marketplace) is a kind of “one-stop shopping” center for commission-free (no sales charge or “no load”) mutual funds and exchange traded funds. The fund marketplace, pioneered in the 1990s by Charles Schwab, has since been copied by several other leading firms, including mutual fund giant Fidelity Investments. Individual investors have access at the press of a mouse click to hundreds of no-load mutual funds (funds purchased with no sales charge or commission), and can sell or exchange funds at any time.

Hedge fund (also private equity funds) marketing is a little less formal. Fund managers recruit investors through their own network of personal connections or from client referrals, investment consultants and other hedge fund managers. Hedge funds sell directly to qualified (or “accredited”) investors, who are individuals with at least $1 million in investable assets (excluding real estate owned), through a hedge “fund of funds” or through third party sales networks. A fund-of-funds is a basket of similar hedge funds that are currently open to accredited investors. Venture capital firms usually sell to interested investors through client referrals or through their own industry contacts.

Investment consultants, who are professionals who advise pension funds and other big investors on investment options, also play an important role in fund distribution. Investment consultants evaluate an investment manager’s “style,” or their method of picking stocks, bonds, and other securities and try to determine what their investment performance looks like when compared to similar managers (large capitalization stocks, small capitalization stocks, etc.) and the market itself. By making these comparisons, the consultant can recommend the investment managers best matching their client’s needs.

Another sales channel targeting wealthy hedge fund investors is the “family office” network. These are basically service firms created to advise groups of wealthy families on investment planning as well as tax and estate planning. The family office business dates to around 1990 when Northern Trust organized the Family Office Forum. Following the success of the Family Office Forum, the Family Office Exchange and the Institute for Private Investors were started up within a few years.

Mutual Funds and Hedge Funds: The Key Differences

Both mutual funds and hedge funds are pooled investments holding a mix of stocks, bonds, financial derivatives, etc., and both are managed by a professional money manager, but there are important differences. Almost anyone can buy a mutual fund, as long as they put up the minimum investment needed to open an account. This can be as little as $250 to $500. Hedge funds are generally limited to wealthy individuals, people with $1 million or more in liquid, investable assets (excluding real estate). These are known as “accredited investors.”

A mutual fund is a publicly traded company that invests in a group of financial assets (stocks, bonds, etc.). The company is really a “shell company.” It has no employees and makes arrangements with third parties—the investment adviser, board of directors, fund distributor, and others—for all of its functional services. Mutual fund companies are tightly regulated by the government—far more than hedge funds—and must be registered with the Securities and Exchange Commission (SEC) as an “investment company,” as directed by the Investment Company Act of 1940. There were 9,414 mutual funds in the United States in 2019, according to the Investment Company Fact Book. This was a significant increase from the 8,003 mutual funds that existed in 1999. Some of the largest mutual fund companies in the United States are Blackrock, Vanguard, Charles Schwab, State Street Global Advisors, and Fidelity Investments.

Investors who put money in a mutual fund are buying shares of stock in the investment company, which in turn buys the stocks, bonds, or other tradable assets described in its fund prospectus. The fund prospectus, part of the fund’s SEC registration, outlines its list of permissible investments and the management fees paid by fund shareholders. The fund raises money by continuously selling shares to the public. Shareholders are free to sell their shares at any time. They can also exchange their ownership interest for shares in another fund sponsored by the same fund distributor.

Careers in the mutual fund sector include financial analysts, buy-side analysts, inve