Investment Management

The investment management industry (IM) manages hedge funds, mutual funds, private equity, venture capital, and other financial investments for third parties, which include companies, pension funds, endowments, insurance companies, private banks, nonprofits, and individuals. The IM industry is also known as the asset management industry. The competent management of hedge funds, mutual funds, and other financial investments provides financial security to Americans, allows companies to grow and prosper, and fuels the U.S. and world economies. The U.S. financial crisis of 2008–2009 and the COVID-19 pandemic underscore how important strong investment management is to the health of the U.S. and world economies.

Hedge funds are privately offered, professionally managed investment vehicles that seek, like all financial investments, a positive annual return, limited variations in value, and the preservation of capital. HedgeFundFacts reports that “hedge funds play a critical role in the financial markets, broadening the use of investment strategies, increasing the number of participating investors, and enlarging the pools of capital available.” According to Hedge Fund Research, hedge fund firms controlled $3.83 trillion in assets in 2022, a decrease from $4.01 trillion at the end of 2021, but up from only $1.5 trillion in managed assets in 2006.

Mutual funds are a group of financial assets (such as stocks) that are managed by a portfolio manager. The Investment Company Institute (ICI) reports that, in 2022, mutual fund companies managed $22.1 trillion in assets (including those of exchange-traded funds, closed-end funds, and unit investment trusts) for more than 115.3 million U.S. investors. Worldwide regulated open-end mutual fund assets were $60.2 trillion at the end of 2022 (up from $46.7 trillion at the end of 2018), according to the ICI. In 2022, the 10 largest firms managed 66 percent of mutual fund and exchange-traded fund assets (up from 46 percent in 2005).

Private equity consists of funds obtained from investors that are then invested in mature, private companies. Over time, private equity firms build up an equity stake in the company with the goal of eventually taking over the company and turning a profit on their investment. Private-equity firms invested more than $1 trillion in communities across the United States in 2021, according to the American Investment Council (AIC). Since 2017, the industry has invested in more than 32,000 businesses. Critics of private-equity firms believe these firms are bad for companies and employees in the long run because they often focus on streamlining or liquidating inefficient or outdated businesses, which often results in people losing their jobs. “The ways in which private equity goes about this restructuring can raise a number of concerns, over such things as layoffs and furloughs for employees and degraded services for customers,” according to ProPublica. “Critics also worry that private equity firms weigh down acquired companies with substantial debt from the money borrowed to finance the purchase.” The AIC counters that “the private equity industry benefits investors, companies, workers, and communities. Investors gain from higher returns and less volatility than public markets. Companies receiving private equity investment benefit from access to capital as well as business mentorship and expertise. Workers benefit from stronger companies that are committed to growth. And communities across the country are bolstered by private equity investment that helps build sustainable companies and jobs.”

Venture capital consists of funds obtained from investors that are invested in young, innovative companies in exchange for an equity stake that hopefully can be translated into a profit when the company goes public or is merged with or sold to another company. The National Venture Capital Association (NVCA) reports that “venture capital is a catalyst for job creation, innovation, technology advancement, international competitiveness, and increased tax revenues.” Some of America’s greatest business success stories were founded with the help of venture capital, including Apple, Amazon, Google, FedEx, Starbucks, Staples, and Intel. In 2021, venture capital firms invested about $345 billion into 18,521 deals, according to the NVCA. The largest area of venture capital investment was in software, where companies received 39 percent of the total funding.

Over the course of the last 100 years or so an entire industry came into existence, built on the idea that professional money managers have the skills to invest their clients’ money safely and with a certain level of confidence. However, investing is still risky business. Money managers are careful to point out in their marketing literature that “past results are not indicative of future performance.” But for investors who don’t have the time or the expertise to manage their investments, investment managers offer some assurances that they have the skill to deliver the goods consistently and reliably over time.

For much of the past century, investors’ choices were limited to traditional investments: stocks, bonds, or cash (or investment pools owning stocks or bonds, such as mutual funds). All were regarded as prudent choices for the average investor. About 25 years ago, the universe of investment options began expanding exponentially. Wealthy individuals and big pension plans wanted to own securities that cushioned their holdings when the markets whipsawed. They began putting more of their money into nontraditional investments: hedge funds, private equity, venture capital, and other alternative investments. Successfully investing with these new options requires additional expertise, making investment management all the more helpful for investors.

Although they have some discretion about how to handle investments, investment managers follow guidelines given by their clients. These might be the investment policy for a pension plan or the prospectus of a mutual fund. These guidelines describe the types of permitted investments, the investment manager’s compensation, and other details of the portfolio. The actual “assets under management” are owned by clients, and investment managers have no physical control or direct access to clients’ assets. Generally third-party custodians, such as trust companies, chosen by clients are contracted to hold the assets. That’s one reason investment managers have small balance sheets and little debt when compared to other financial services firms.

Investment managers play a unique role in the financial services industry. Their business model is fundamentally different than commercial banks, investment banks, or insurance companies. Investment banks act as principal in proprietary trading, securities underwriting, and prime brokerage; commercial banks access their depositor base or the capital markets to make consumer and business loans; finance companies tap the capital markets and essentially re-lend these funds; and insurance companies provide long-term financing for real estate.

On the other hand, investment managers are paid on a schedule based on the amount of assets under their management. The revenue sources for managing investments are the fees for the advisory services provided—selecting securities and managing the portfolio according to the client’s guidelines. The fee structure generates a more stable income stream than that of an investment bank or any other transaction-oriented financial institution.

Another important difference between a commercial bank and an investment manager is the absence of government backing such as deposit insurance. Banks accept deposits that, in the United States, are insured by the Federal Deposit Insurance Corporation. Investment managers have no such safety net. They clearly disclose to clients that investment performance is not guaranteed by the manager, the government, or any other party.

Investment managers represent their clients in making buy or sell decisions, acting as trusted agents. Their income is typically a percentage of the funds managed, which means a manager’s earnings can vary widely from one year to the next. A major sell-off in the stock exchanges can sharply reduce earnings.

Investment managers do not invest with their own funds (other than seed capital or small co-investments) or make promises about expected investment performance.

Taking a top-down view, more than 9.6 million Americans worked in business and financial operations careers in one capacity or another as of May 2022, according to the U.S. Department of Labor. Many are involved every day in the world of investing in four different classes of investments: mutual funds, hedge funds, private equity, and venture capital. They advise clients, analyze securities, make investment and trading recommendations, run investment portfolios, or perform other essential duties.