Structure of the Investment Industry

The investment industry helps individuals, companies, and governments save and invest money for the future.

Companies save to invest in future projects and to pay future salaries, taxes, and other expenses. The investment industry provides services to those who have money to invest individual and institutional investors who become providers of capital.

Investors must :

• determine their financial goals in particular, how much money they will need to invest for future uses and how much money they can withdraw over time.
• identify potential investments.
• evaluate the risk and return prospects of potential investments.
• trade securities and assets.
• hold, manage, and account for securities and assets during the periods of the investments.
• evaluate the performance of their investments.

Investors obtain assistance with these activities from investment professionals, either directly by hiring investment professionals or indirectly by investing in investment vehicles that the investment industry creates and oversees. Some investment firms and professionals working in the investment industry specialise in providing a single service.

FINANCIAL PLANNING SERVICES

Investment clients often need advice to set their financial goals and determine how much money they should save for future expenses. Financial planners help their clients understand their current and future financial needs, the risks they face when investing, their ability to tolerate investment risks, and their preferences for capital preservation versus capital growth.

Financial planners create savings and investment plans appropriate for their clients' needs. The plans often require complex analyses that depend on expected rates of return and risks for various securities and assets, the client's capacity and tolerance for bearing risk, tax considerations, and projections of future expenses. They may depend on inflation and, in the case of retirement expenses, uncertain longevity and uncertain future health care expenses. Some employers also contract with financial planning consultants to make financial planning services available to their employees and retirees. Increasingly, financial planners provide financial planning advice over the internet to retail investors. Various organisations require financial planning services to help them meet their investment objectives. For example, foundations and endowment funds which are not-for-profit institutions with long-term investment objectives sometimes hire financial planners to help them create their payout policies. The payout policies depend on the assumptions the financial planners make about future expected investment returns.

INVESTMENT MANAGEMENT SERVICES

The types of services investors have access to for help with investment management activities depend on the amount of investable assets they have.

Services for High-Net-Worth and Institutional Clients : Some high-net-worth and institutional clients rely on investment professionals to take care of the entire investment process, from identifying potential investments to implementing the investments and evaluating their performance; others use the services of investment professionals selectively. Depending on the context, these terms may refer to the individuals who make investment decisions or to the investment firms for which they work. To determine the appropriate allocation to each of the various asset classes, investment managers must assess the risk and return characteristics of many potential investments.

Investment analysis involves estimating the fundamental value of potential investments and identifying attractive securities and assets. An investment's fundamental value, also called intrinsic value, indicates the price that investors would pay for the investment if they had a complete understanding of the investment's characteristics. A widely used approach to estimating the fundamental value of an investment is to estimate the present value of all the cash flows that the investment will generate in the future. Recall from the Equity Securities section that the value of a common share can be estimated as the present value of all the cash flows, such as dividends, that the investor expects to receive from the common share in the future. It requires investment managers to invest in the attractive securities and assets they identified through their investment analysis, taking into account the client's requirements and appropriate asset allocation. To do so, investment managers must trade securities and assets; hold, manage, and account for these securities and assets during the periods of investment; and evaluate the performance of these investments.

The investment managers who provide assistance to high-net-worth and institutional investors typically work for investment firms. Clients may also pay performance fees that depend on the investment performance of the portfolio. Passive investment managers seek to match the return and risk of an appropriate benchmark. Passive investment strategies are the least costly strategies to implement because they involve buying and holding securities based only on their characteristics rather than on analyses of their future return prospects. The managers then act on their opinions by buying the securities and assets that they expect to outperform and selling??the securities and assets that they expect to underperform.

Active investment strategies are more expensive than passive investment strategies because they require greater resources, so investment clients hire active investment managers only when they believe that these managers have the skill to outperform the market after taking into consideration all fees and commissions. Active investment managers collect and analyse as much relevant information and data as they can reasonably obtain to predict which securities and assets will outperform or underperform their peers in the future. They often need the help of investment information service providers to gather the required information and data. Some investment professionals receive commissions from the firms that sell mutual funds and life insurance policies for the trades and contracts they recommend.

INVESTMENT INFORMATION SERVICES

Many investors and investment managers obtain investment research, financial data, and consultancy services from firms that specialise in providing these services. These companies include investment research providers, credit rating agencies, financial news services, financial data vendors, and investment consultants.

Firms that provide research reports assemble information and opinions that most investors cannot easily produce themselves. To produce the reports, these firms employ data collectors, financial reporters, and expert analysts.

Research reports can be particularly valuable when they are written by industry experts who understand the financial implications of new industrial technologies for example, the fracking technologies that oil and gas drillers now increasingly use to extract hydrocarbons. Brokers give research to their clients to better serve them, to attract new clients, and to encourage their clients to trade. Investors may also purchase reports directly from independent research firms, or they may obtain reports from research firms that issuers pay to produce reports about their securities.

Credit Rating Agencies : Credit rating agencies specialise in providing opinions about the credit quality of bonds and of their issuers. Most credit rating agencies do not charge investors for their ratings, although they may charge them for the detailed reports on which the ratings are based. An obvious conflict of interest thus arises because companies are likely to direct their business to those credit rating agencies that will provide higher ratings. If they lose their independence, credit rating agencies run the risk that investors may no longer respect their ratings.

Data Vendors : To invest and trade successfully, most investors need current and accurate data about companies and market conditions. The following are important real-time data resources used by investment professionals:

Newsfeeds, which provide real-time news about companies and markets that investors need to know because such news may affect the value of the companies' securities.

Market data feeds, which provide real-time information about market quotes and orders, as well as recent trades, that is helpful for investors who want to trade. The growth of information technologies, particularly those involving the internet, has substantially reduced the cost of accessing data, so more investment data are now available to the general public.

TRADING SERVICES

Brokers, dealers, clearing houses, settlement agents, custodians, and depositories provide various services that facilitate investment by helping buyers and sellers of securities and investment assets arrange trades with each other and by holding assets for clients.

Brokers : Brokerage services are provided to clients who want to buy and sell securities; they include not only execution services (that is, processing orders on behalf of clients) but also investment advice and research.

Brokers are agents who arrange trades for their clients. Instead, they search for traders who are willing to take the other side of their clients' orders. Brokers help their clients by reducing the cost of finding counterparties for their clients' trades. First and foremost, brokers find sellers for their clients who want to buy and buyers for their clients who want to sell. Clients pay commissions to their brokers for arranging their trades. For such trades, brokers guarantee the settlement of their clients' trades. Many simply route their clients' orders to exchanges or to dealers.

Prime brokerage refers to a bundle of services that brokers provide to some of their clients, usually investment professionals engaged in trading. Thus, prime brokerage allows the netting of collateral requirements across all their trades and the lowering of costs of financing to the trader.

Dealers : Dealers make it possible for their clients to trade without having to wait to find a counterparty; they are ready to buy from clients who want to sell and to sell to clients who want to buy.

Dealers thus participate in their clients' trades, in contrast to brokers who do not trade with their clients but only arrange trades on behalf of their clients. Dealers provide liquidity to their clients by allowing them to buy and sell when they want to trade. In effect, dealers match buyers and sellers who want to trade the same instrument at different times and are thus unable to trade directly with each other.

Dealers are often called market makers because they are willing to make a market??in specified securities at their bid and ask prices. Many dealers also broker orders, and many brokers also deal with their clients in a process called internalisation.

Internalisation is when brokers fill their clients' orders by acting as proprietary traders rather than as agents that is, by trading directly with their clients rather than by arranging trades with others on behalf of their clients.

Broker/dealers face a conflict of interest with respect to how they fill their clients' orders. When acting as brokers, they must seek the best price for their clients' orders. When acting as dealers, however, they profit most when they sell to their clients at high prices or buy from their clients at low prices. This trading conflict of interest is most serious when clients allow their brokers to decide whether to trade their orders with other traders or to fill them internally. Consequently, when trading with broker/ dealers, some clients may specify that they do not want their orders to be internalised.

The primary dealers then sell the bonds to their clients. Central banks buy bonds from primary dealers to increase the money supply, the primary dealers buy bonds from their clients and sell them back to the central banks. Thus, brokers and dealers who are not members of the clearing house must arrange to have a clearing member settle their trades at the clearing house. Custodians and Depositories Custodians are typically banks and brokerage firms that hold money and securities for safekeeping on behalf of their clients. Custodians may also offer other services for their clients, including trade settlement and collection of interest and dividends. The fees they charge their clients often depend on the type of services they provide to them. Their brokers, in turn, hold the securities with custodians and depositories for safekeeping.

ORGANISATION OF FIRMS IN THE INVESTMENT INDUSTRY

Practitioners classify many firms in the investment industry by whether they are on the sell side or the buy side.

Sell-side firms primarily provide investment products and services; they are typically investment banks, brokers, and dealers. Buy-side participants purchase these investment products and services from sell-side firms. Practitioners also sometimes use the term buy side to refer to consultants who provide services only to buy-side firms.

However, the buy-side/sell-side classification does not apply to all firms in the investment industry. In addition, the buy-side/sell-side classification is somewhat arbitrary and not easily applied to many large, integrated firms. These functions are on the buy side, even though investment banks are sell-side firms. Activities are classified by whether they are in the front office, the middle office, or the back office. The sales, marketing, and customer service departments are the most important front-office activities. the middle office as IT activities are particularly important because most firms in the investment industry need to process and retrieve vast quantities of data efficiently and accurately. Risk management activities are also critical because they help ensure that the firm and its clients are not intentionally, inadvertently, or fraudulently exposed to excessive risk. The back office houses the administrative and support functions necessary to run the firm. For example, compliance activities are relevant to the entire organisation. The terms front office, middle office, and back office are generally not used when describing buy-side firms. However, the main departments of buy-side investment management firms are similar to those of sell-side firms.

LEADERSHIP TITLES AND RESPONSIBILITIES AND INVESTMENT STAFF

• Chief executive officer (CEO) : Manages the firm.
• Chief financial officer (CFO) : Responsible for financing the firm and for financial reporting.
• Chief operating officer (COO) : Responsible for the day-to-day management of the firm.
• Chief investment officer (CIO) : Responsible for any investment advice that the firm provides to its clients and for the investment decisions that the firm makes for itself and on behalf of its clients.
• Head trader : Responsible for all trading operations. At firms that engage in proprietary trading, the head trader is responsible for all positions, risks, and profits.
• Chief accountant (finance controller) : Responsible for the accounting and financial systems.
• Treasurer : Responsible for cash management, including the investment of receipts and payment of invoices.
• Chief risk officer : Responsible for identifying and managing the risks to which the firm and its clients are exposed.
• Chief compliance officer : Responsible for ensuring that the firm complies with all constraints placed on it by laws, regulations, and clients.
• Chief audit executive : Leads the internal audit department, which is responsible for providing independent assessments of the firm’s operational systems as well as suggestions for improvement.
• General counsel : Leads the legal department, which reviews and helps write contracts, responds to or initiates lawsuits, and interprets regulations, among many other activities.

For example, the chief investment officer of a smaller investment management firm may also be the chief executive officer. Firms in the investment industry employ many types of investment professionals.

Examples include the following:

• Portfolio managers at buy-side firms make investment decisions for one or more portfolios.
• Buy-side, sell-side, and independent research analysts produce the investment research that portfolio managers use to make decisions.
• Research assistants assist research analysts with the collection and analysis of investment information.
• Sales traders at sell-side firms help arrange trades for their buy-side clients.
• Salespeople identify potential clients and sell them the firm's products and services.

Investment professionals who interact with clients may also be known as account executives and account managers at many firms. Research assistant is often the entry-level position for investment professionals interested in becoming portfolio managers. Likewise, sales assistants and account services assistants are entry-level positions for investment professionals interested in sales or account services.

Slahdji Mohamed Oussalem