How Is Your Money Managed?
Each investment company has its own tailored investment objective set by the board. There is usually a benchmark for performance to be measured against.
Investment objectives are worded differently but will often be along the lines of “delivering a return to shareholders in excess of the benchmark”.
The boards of some investment companies decide that the company will manage its own investments. These are called self-managed companies. Most decide to outsource the job of managing the portfolio to specialist investment managers. These are called externally managed companies.
Benchmarks vary according to what the fund is invested in and what it is trying to achieve but can be: equity index a fixed rate of return the rate of return on a government bond an interest rate.
- equity index
- a fixed rate of return
- the rate of return on a government bond
- an interest rate.
Often the board will set parameters for the investment manager. These might include:
- the size of the largest investment
- how concentrated the portfolio is allowed to be
- the maximum exposure to a country or an industry sector
- how much borrowing the manager is allowed to use
- or whether they are allowed to use alternative investments such as derivatives (options and futures).
The manager chooses investments based on their view of how attractive they are. Some managers select individual investments they like and assemble these into a portfolio. This is often called bottomup stock selection. Others may decide first what geographies, industry sectors and investment themes they like and then decide what investments will fit within those criteria. This is called top-down stock selection.
Some managers will make investments based on the constituents of the benchmark. They will look at the size of each member of the benchmark and decide whether to take an underweight or overweight position relative to the benchmark. A portfolio that exactly matched the benchmark in terms of constituents and weights is an index tracker. Investors who make more independent decisions are known as active investors.
Investment managers may like to hold companies for the long-term or choose to trade more frequently. There are pros and cons on each side. For instance, low turnover may indicate patience and the ambition to keep a cap on trading costs. Meanwhile, high portfolio turnover adds to trading costs. Portfolio turnover figures measure the extent of buying and selling activity. This is usually worked out as the value of purchases plus sales divided by the average value of the portfolio.