Investment management

Investment management is the specialty area within finance dealing with the management of individual or institutional funds. Other terms commonly used to describe this area of finance are asset management, portfolio management, money management, and wealth management. In industry jargon, an asset manager “runs money.”
Investment management involves five activities: (1) setting investment objectives, (2) establishing an investment policy, (3) selecting an investment strategy, (4) selecting the specific assets, and (5) measuring and evaluating investment performance. We describe these activities in Chapter 17. Setting investment objectives starts with a thorough analysis of what the entity wants to accomplish. Given the investment objectives, policy guidelines must be established, taking into consideration any client-imposed investment constraints, legal/regulatory constraints, and tax restrictions. This task begins with the asset allocation decision (i.e., how the funds are to be allocated among the major asset classes). Next, a portfolio strategy that is consistent with the investment objec tives and investment policy guidelines must be selected. In general, portfolio strategies are classified as either active or passive. Selecting the specific financial assets to include in the portfolio, which is referred to as the portfolio selection problem, is the next step. The theory of portfolio selection was formulated by Harry Markowitz in 1952. This theory, as we explain in Chapter 17, proposes how investors can construct portfolios based on two parameters: mean return and standard deviation of returns. The latter parameter is a measure of risk. An important task is the evaluation of the performance of the asset manager. This task allows a client to determine answers to questions such as: How did the asset manager perform after adjusting for the risk associated with the active strategy employed? And, how did the asset manager achieve the reported return?
Our discussion in Chapter 17 provides the principles of investment management applied to any asset class (e.g., equities, bonds, real estate, and alternative investments). In Chapters 18 and 19, we focus on equity and bond portfolio management, respectively. In Chapter 18, we describe the different stock market indicators followed by the investment community, the difference between fundamental and technical strategies, the popular stock market active strategies employed by asset managers including equity style management, the types of stock market structures and locations in which an asset manager may trade, and trading mechanics and trading costs. In Chapter 19, we cover bond portfolio management, describing the sectors of the bond market and the instruments traded in those sectors, the features of bonds, yield measures for bonds, the risks associated with investing in bonds and how some of those risks can be quantified (e.g., duration as a measure of interest rate risk), bond indexes, and both active and structured bond portfolio strategies.
We explain and illustrate the use of derivatives in equity and bond portfolios in Chapters 20 and 21. In the absence of derivatives, the implementation of portfolio strategies is more costly. Though the perception of derivatives is that they are instruments for speculating, we demonstrate in these two chapters that they are transactionally efficient instruments to accomplish portfolio objectives. In Chapter 20, we introduce stock index futures and Treasury futures, explaining their basic features and illustrating how they can be employed to control risk in equity and bond portfolios. We also explain how the unique features of these contracts require that the basic pricing model that we explained Chapter 6 necessitates a modification of the pricing model. We focus on options in Chapter 21. In this chapter, we describe contract features and explain the role of these features in controlling risk.