Investment banks and investment management firms play significant roles within the world of finance. The impact of their activities can also extend well beyond the financial sector. However, the differences between investment banking and investment management may at first, seem unclear or confusing, particularly for those new to finance. This article will explain the key differences between investment banking and investment management.
Buy-side vs. Sell-side
Before trying to understand the differences between investment banking and investment management, it is important to understand how the playing field in finance is set up. Typically, firms are categorised into two ‘sides’ – that is, the buy-side and the sell-side.
The buy-side generally refers to firms that focus on purchasing securities (such as stocks, bonds, and alternative assets). These may include hedge funds and retail investors. In contrast, the sell-side refers to firms that issue, sell, or trade securities.
Investment managers are situated on the buy-side, whereas investment banks are situated on the sell-side. To see why this is the case, we can look further at what these two types of firms do.
When the average consumer thinks of a bank, they may picture their local branch in which they deposit a cheque or take out cash. These banks, referred to as retail banks, are different to investment banks (although it is worth noting that many big investment banks also have retail banking arms).
The fundamental role of an investment bank is to assist companies, governments, and corporations who are looking to raise capital . Ultimately, companies require capital to grow. They also need capital in order to acquire other assets, invest in new ventures, expand into new regions, and to finance operations. Investment banks play a key role in helping companies to raise capital and they provide financial advisory to clients on corporate finance matters. Here, we will consider two key areas of work that investment banks provide.
Underwriting: Stock and Bond Issuance
Issuing bonds and stocks is one of the main ways that a company can raise capital. However, the process of issuing these securities is complex and generally requires expertise in the financial markets. Hence, companies hire investment banks to act as underwriters for stock and bond issuance.
In investment banking, underwriting refers to the process of raising capital for a client through selling equity or debt securities . This typically involves the sale of stocks or bonds to investors through financial activities such as an initial public offering (IPO). An IPO is where a company lists its shares to the public for the first time. Through selling its shares to the public, a company can raise large amounts of capital.
Investment banks are responsible for attracting investors that may buy issued stocks or bonds. Investment banks create a prospectus that can be given to potential investors. The prospectus provides information about the company and explains the terms of the offering, such as the number of issued shares and the initial stock price. It is crucial that the terms of the offering are set in a way that provides the best results. For instance, if the stock price is too high, it could fail to attract a sufficient number of investors. If the stock price is too low, it may struggle to raise enough capital for the client. Hence, investment banks are often employed to attract buyers and to ensure that the issuing of stock or bonds is carried out effectively.
M&A stands for mergers and acquisitions. This is where a company either buys another company (an acquisition) or two companies merge to become a single company (a merger). Investment banks typically advise clients on the value and structure of M&A deals, and help their client get the best out of any proposed deal.
For firms looking to acquire, investment banks may provide financial valuations of companies in order to determine the value of a deal. This may be done through valuation techniques such as DCF models or comparable company analysis. For targeted companies, investment banks will help structure the M&A deal in a favourable way and advise on a reasonable asking price.
Investment banks also carry out due diligence, where financial records are examined before entering into a transaction. This helps clients identify any issues or challenges that may not have been obvious at first.
Large investment banks typically have dedicated research teams that gather information about companies and offer recommendations on whether to buy or sell their stock . These reports, often called equity research reports, may either be used internally for investment purposes, or sold to buy-side firms.
Investment banks have a sales and trading department which facilitate trades between buyers and sellers. Investment bankers are licensed to trade on stock exchanges and may execute stock or bond transactions on behalf of their clients.
Unlike investment banks, investment management firms are situated on the buy-side. In simple terms, an investment management firm invests their clients’ money with the aim of generating returns on investments .
Choosing the best investments on the market is challenging for anyone. Potential assets range from fast-growing stocks and slow-growing bonds to more alternative assets such as real estate. Each type of asset has its own associated risks and potential rewards.
Therefore, many investors and companies pay investment management firms to create a portfolio that is specifically tailored to their investment goals and risk appetite. Over time, a client’s money is invested into various asset classes and managed with a certain strategy in mind – hence the name, investment management.
What draws clients to investment managers is their expertise and the access that they provide to investment options. For instance, some investment management firms provide clients with direct access to financial products like funds.
Types of Investment Management
The first step for any investment manager is to understand the financial goals and risk appetite of the client. From then on, they can tailor an investment portfolio to match the client’s needs. A portfolio is simply a selection of assets. How a portfolio is constructed (meaning which assets are invested in and how much is invested) varies depending on the client and market conditions. The investment manager will then manage the portfolio whilst assessing its performance and monitor any potential changes that need to be made to satisfy the client.
Two main types of investment management are asset management and wealth management. While they are similar, they do differ in their aims.
Among other things, asset managers help with asset allocation, which involves determining how investment should be spread across various asset classes. Potential assets that may be invested in include stocks, bonds, funds, and alternative assets. There are various types of clients who may pay for the services of asset managers, such as insurance companies, pension funds, and high net-worth individuals.
In comparison to asset management, wealth management looks at the wider picture for a client. This may include designing a portfolio that also considers factors such as insurance, pension schemes and tax planning. Typical clients include high net-worth individuals or those seeking help from a financial advisor.
Asset Classes and Risk-Reward
One of the key principles in investment management is the concept of a trade-off between risk and reward. Generally, the higher the risk of a given investment, the higher the potential return. Similarly, low-risk investments generally lead to lower levels of returns. An investment manager will allocate funds into a selection of assets with the aim of balancing the potential for returns and the carried risk.
Figure 3 shows various asset classes and their associated risk-reward levels over an annualised 10-year period. In general, stocks are seen as a riskier investment than bonds or cash but can provide greater returns. Similarly, alternative assets such as real estate, private equity, and commodities are deemed relatively risky, though returns vary depending on the exact investment made. Furthermore, derivatives like futures contracts are seen as very risky as they are effectively like betting on the market .
Depending on the financial goals and time horizon of investment (how long the investor plans to invest for), an investment manager will decide how to allocate funds into different asset classes. They will decide what percentage of investment goes into riskier assets like equity (e.g. stocks) and what percentage goes into less risky assets like fixed income (e.g. bonds).
This article has tried to make clear the key differences between investment banking and investment management. In short, investment banking is about raising capital for clients and providing advisory on corporate finance matters. On the other hand, investment management is about helping a client invest in assets to achieve financial growth.
 Singal, V. (2018), Derivatives, CFA Institute Investment Foundations, 3rd Edition, Chapter 11
MSci student at the University of Bristol studying Physics and Philosophy