Types of Investment Companies and Their Strategies
Overview of Fund Management Strategies
Top-down investing is where the assets are chosen based on an overarching theme; this can be split by sector or asset type. While this has the potential to benefit from economic events, there is no guarantee that the assets chosen to represent these themes would subsequently benefit. Bottom-up investing is the opposite, where individual companies and securities are thoroughly researched and invested in regardless of the wider economic environment. [1]
Fundamental analysis may be used to investigate all the main factors concerning a business. This would include looking at the financials of the business, its management, external factors and its stakeholders. Technical analysis on the other hand, looks at prior trading patterns for the specific security. While in the long term, fundamentals tend to drive the stock price, technical analysis may be a more accurate reading of short-term fluctuations in price. Contrarian investing is where managers choose to invest in unpopular securities at the time, that are undervalued by some metric. It therefore still focuses on value investing instead of growth investing. Dividend investing is where investors focus on the historical earnings and dividends of a business, with a focus on the dividend income rather than the stock price fluctuations.
In reality, a mixture of these techniques tend to be used in order to provide diversification, as well as different techniques being more suitable for different types of investors, i.e. dividend investing may be more suitable for someone looking to retire soon, as they may want the dividends to supplement any pension income. Firms tend to have a unique investment philosophy, which dictates which strategies are used and to the extent they are used; thereby there are also differences in their end clientele at times. [2]
Investment Management Corporation
Large companies who have billions of dollars of AUM (Assets Under Management) fall into this category. This includes the likes of BlackRock and The Vanguard Group. They tend to offer an incredibly large range of products and services for clients, who often include both private individuals, as well as large institutional investors (often pension funds or insurance providers). The advantages for these firms, is that they are often able to pioneer new investment products and are able to offer competitive fee structures as their AUM is spread across a large number of investment vehicles. [3]
Boutique Fund Managers
The main difference between boutique fund managers and larger corporations is that boutique fund managers tend to have more specialist, focused strategies. Boutique fund managers do not suffer from the same effects of market impact, i.e. with a smaller AUM, each time they trade, the resulting impact on the stock market is less. If a manager wanted to buy a certain amount of stock, the price difference between what they paid for the first share and the last share would be smaller, as the demand this created would not have increased price as much as a larger fund would have. Furthermore, smaller funds may not run into issues of ownership, especially in smaller growth stocks where larger ones might hit the maximum ownership allowed by regulation without investing as high a percentage of their portfolio in it. This also means that fund managers are not stretched over as many firms or categories and therefore, their research may be more detailed and choices more informed. However, they do suffer in terms of having less income available to pay off the increasing overheads caused by new regulations. Regulation has also impacted wealth management and independent financial advisory services, resulting in much larger pools of capital being deployed into certain strategies, where larger funds are often more capable of accepting this capital. [4]
Hedge Funds
Hedge funds pool together investors’ funds and invest them in unconventional strategies. They are often set up as private investment limited partnerships and are subject to less regulation due to the nature of their investors. They normally have restrictions on the type of investors (they have to be financially sophisticated and therefore, need less stringent regulation based on their income, net worth, asset size, governance status or professional experience) and even the number, as well as on the amount of money invested. There is also usually a ‘lock-up’ period at the start, where investors are unable to take out their funds. There are also limited opportunities to withdraw funds, with certain set intervals providing the opportunity. [5]
Their strategies tend to be active and allow them to use leverage, derivatives and short positions on securities. Long/short equity is one example of a strategy, whereby they take long positions in some firms to finance the short positions in firms where they believe the share price will fall. Whilst most managers tend to have larger long than short positions, some use a market neutral strategy whereby they are equal. They may also take part in merger arbitrage, which occurs when there is a takeover in the market. They tend to take a long position in the target company and short the acquirer, due to the premium that is often paid in these sorts of deals. [6]
Convertible arbitrage is used where the hedge fund is long on the convertible bonds and short on a proportion of the shares they convert into. A delta-neutral position is often targeted, whereby the bond and stock positions offset each other. This requires further buying and selling with price fluctuations. Other event-driven strategies may include buying distressed debt, with a focus on senior debt obligations, which are most likely to be paid off, even in the event of bankruptcy. Credit hedge funds also exist, where they trade different classes of securities in the same firm or the same credit quality between different firms and tranches. These can invest in structured debt vehicles such as CLOs (Collateralized Loan Obligations) and may short interest rate-based securities as a hedge. Fixed-income arbitrage is free of credit risk and uses government bonds. It is based on managers predicting how the yield curve will change and uses leverage to increase potential returns (and losses). Global macro is based on investing in broader asset classes and may not always hedge. Short-only hedge funds involve finding firms where they believe the price is overvalued. Quantitative hedge funds rely on quantitative analysis. An example of such a firm would be one which uses high-frequency trading (HFT).
Private Equity
This is essentially where investors own a part of a firm or business which is not publicly listed- i.e. private. Investors in this industry tend to be more sophisticated or to be chasing potentially higher returns than what is available publicly, as there is more regulation and expertise required in order to make a return and there are often minimum investment requirements exceeding £100, 000. This is because private equity firms tend to take a large (often controlling) stake in firms, to try and steer the business towards making a larger profit. This may involve vast changes, which draw criticism (i.e. redundancies to increase efficiency) as they may be beneficial for the timeframe the private equity firm wants to retain control (often between 4 and 7 years), but not have the long term interests of the business in focus; i.e. once it has been sold off at a hefty profit. [7]
Venture Capital
This is considered a type of private equity. [8] It focuses on providing funding to start-ups or other early stage businesses which have a large growth potential. It often also includes help with running the business, whether that be on a more management or technical basis. Therefore, firms which may have trouble accessing other sources of finance, or who want help with running certain aspects of the business, which may be holding them back from becoming profitable, tend to be open to this sort of investor. However, there is a large risk for the investor, as for every business that does succeed and goes on to be a vastly profitable corporation, there are countless others which fail. Furthermore, depending on the terms of the investment, the investor may have to sell off his share before the company does reach its full potential in order to meet their return on investment requirements; they often tend to exit the company after about 5 years, during an IPO, merger or acquisition (which essentially would have been the target for the start-up as these would provide further funding and growth opportunities). Also, the available range of companies may be inherently biased, as some start-up firms may not be open to this sort of funding, as they do not want to give up some of the ownership and control of their business. Investors in this space do vary in terms of how hands on they are, however, silent investors (where they only put up funds without having a say) tend to be considered a separate category. [9]
[1] https://www.bankrate.com/investing/6-common-investment-strategies-of-fund-managers/
[2] https://www.investopedia.com/terms/i/investmentstrategy.asp https://www.investopedia.com/terms/i/investing_style.asp
[4] https://www.ipe.com/main-navigation/boutique-asset-managers-best-of-both-worlds/44616.article https://www.ftadviser.com/investments/2019/08/06/what-future-do-boutique-fund-managers-have/?page=2
[5] https://www.investopedia.com/terms/h/hedgefund.asp
[6] https://www.investopedia.com/articles/investing/111313/multiple-strategies-hedge-funds.asp
[7] https://www.investopedia.com/terms/p/privateequity.asp
[8] https://www.investopedia.com/terms/v/venturecapital.asp
[9] https://yourbusiness.azcentral.com/silent-investor-work-27810.html