What is Discretionary Investment Management?

What is Discretionary Investment Management?

Discretionary investment management is a form of investment management in which buy and sell decisions are made by a portfolio manager or investment counselor for the client’s account. The term “discretionary” refers to the fact that investment decisions are made at the portfolio manager’s discretion. This means that the client must have the utmost trust in the investment manager’s capabilities.

Discretionary investment management can only be offered by individuals who have extensive experience in the investment industry and advanced educational credentials, with many investment managers possessing one or more professional designations such as Chartered Financial Analyst (CFA), Chartered Alternative Investment Analyst Chartered Alternative Investment Analyst (CAIA), Chartered Market Technician (CMT) or Financial Risk Manager (FRM).

How Discretionary Investment Management Works

Discretionary investment managers demonstrate their strategies using a systematic approach that makes it easier to report results and for investment strategies to be exercised in a specific way. Investments are not customized or tailored to a client; rather, investments are made according to clients’ strategies.

 In other words, clients are grouped according to their highlighted goals and risk tolerance. Each group will then have the same investment portfolio created from the pool of money deposited by the clients. The actual client account is segregated and the funds invested are weighted to the individuals’ capital investments.

For example, consider a portfolio with an initial capital of $10 million. A high-net-worth individual that contributed $1 million will be said to have a 10% investment in the portfolio, while another that contributed $300,000 will have a 3% investment in the portfolio.

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Benefits of Discretionary Investment Management

Utilizing a discretionary investment manager offers the following benefits:

1. Convenience

Clients do not need to spend time worrying about their investment performance; they can simply just invest their capital with a professional who will monitor their investments on their behalf.

2. Excess returns

When investment managers are given the right incentives, they will try to earn excess returns for clients above their benchmark.

3. Access to professional insight

Investment managers are usually professionals who understand the financial markets and investing more than the average person; in theory, it should lead to better performance than investing personally.

4. Economies of scale

Clients can pool their capital together and access economies of scale in the form of lower trading fees and block trades.

Risks of Discretionary Investment Management

The risks involved in using a discretionary investment manager include:

1. Fees

Discretionary investment managers charge a fee for their services, and it takes a portion out of the end return that a client receives.

2. Underperformance

Due to the unpredictability of financial markets, there is a solid possibility that the investment manager will actually underperform their benchmark.

3. Confidence in the manager

Clients must maintain the utmost confidence in the investment manager to make the best investment decision; however, many clients may become fearful when they begin losing money and want to pull their capital out from the discretionary investment manager, which limits the manager’s ability to execute on their strategies.