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 the Chartered Financial Analyst (CFA) designation. Discretionary investment management is generally only offered to high-net-worth clients who have a significant level of investable assets.

Services and transactions under discretionary investment management are tailored to high-net-worth individuals (HNWI) and institutional investors, such as pension funds, since discretionary accounts have higher minimum investment requirements, often starting at $250,000. The investment manager's strategy may involve purchasing a variety of securities in the market, as long as it falls in line with his or her client's risk profile and financial goals. For example, discretionary investment managers can purchase securities such as stocks, bonds, ETFs and financial derivatives.

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 initial capital of $10 million. A HNWI 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.

Discretionary investment management offers a number of benefits to clients. It frees clients from the burden of making day-to-day investment decisions, which can arguably be better made by a qualified portfolio manager who is attuned to the vagaries of the market. Delegating the investing process to a competent manager leaves the client free to focus on other things that matter to him or her.

Discretionary investment management also aligns the investment manager's interest with that of the client, since managers typically charge a percentage of the assets under administration as their management fee. Thus if the portfolio grows under the investment manager's stewardship, the manager is compensated by receiving a higher dollar amount as the management fee. This reduces the adviser's temptation to "churn" the account in order to generate more commissions, which is a major flaw of the transaction-based investment model.

Discretionary investment management may also ensure that the client has access to better investment opportunities through the portfolio manager. The client may also receive better prices for executed trades, as the portfolio manager can put through a single buy or sell order for multiple clients. For clients in discretionary accounts, portfolio managers can act on available information quickly and efficiently, selling the position out of all their accounts in a single, cost-effective transaction. Likewise, the portfolio manager is better positioned to seize buying opportunities when the markets dip and a good quality stock temporarily drops in value.

From the client's point of view, he or she must have confidence in the portfolio manager's competence, integrity and trustworthiness. It is therefore incumbent upon clients to conduct adequate due diligence on potential portfolio managers before entrusting them with their life savings.