Investment management vs. investment banking: What's the difference?
Understanding how different companies operate in the financial markets can be difficult, especially as it’s changing all the time. But knowing what the key players actually do and how they differ can be useful as a starting point.
I asked a colleague, Andrew Lacey, about confusion over the difference between investment management and investment banking. He told me: ‘I think most people see the City as just a maze of tall buildings full of people screaming “buy” and “sell”, and honestly? I can’t blame them.
‘When I was working as an investment manager, I tried to explain my job to my dad once. He has a basic understanding of financial markets, and when I told him I invested money and worked for a bank, he quite reasonably deduced I was an investment banker. But I wasn’t. That’s a wildly different profession. When I tried to explain the difference he got so frustrated he nearly flipped the table. In truth, I get confused myself sometimes.’
To help clear up some of the confusion, this article aims to demystify the roles of the investment managers and the investment banks. What is the difference?
The investment banks
These ‘banks’ are not your usual bank that you see on the High Street - although confusingly the owners of many retail banking brands, such as Barclays, HSBC and RBS, also have investment banking arms operating under the same name.
Investment banks do not take deposits as such, but rather assist in a number of financial roles for companies and corporations, which pay for the expertise of the investment bank in accessing the financial markets.
The idea is to put those that are looking to raise more money (e.g. the companies) in contact with those that have money (e.g. asset managers - read on for that bit!). Investment banks are often referred to as the ‘sell-side’, due to the nature of their work, as will be explained in more detail in a bit.
Three main areas that investment banks specialise in are:
1. Mergers and acquisitions (or M&A)
This is where a company either buys another company (an acquisition, or two companies merge to become a new company (a merger).
These deals are often done when firms want to access new markets, to gain new customers.
Or they could be buying up a rival to reduce competition and benefit from economies of scale. If they are trying to control the production and sale of their products from start to finish, this is often referred to as ‘vertical integration’. An example would be a brewer buying a pub-owning company.
2. Debt and equity issues - or the ‘primary market’ and the ‘secondary market’
Companies that look to raise money may go to an investment bank to help orchestrate a deal to sell some of their debt in the form of bonds, or equity, in the form of shares.
An initial public offering (IPO) or float is where a company (i.e. one that is not listed) raises money by offering its shares to the public for the first time. It is then listed on a stock exchange.
A recent example of this could be Uber’s IPO or Snap Inc’s (owner of Snapchat) last year. The investment bank will look to set up this arrangement, to find buyers of these issues and to act as an underwriter (essentially a guarantor) for the deal in many cases.
This initial offering of debt and equity is often referred to as the ‘primary market’ as it is the first time this type of debt or equity has been traded. Once these new issues are complete, the bonds or shares can be traded on the ‘secondary market’.
3. Investment brokerage
Many investment banks offer a ‘broker’ service, whereby sellers and buyers are brought together. A large proportion of asset managers do their trading through these brokers, as they have licences to trade on the stock exchange.
Investment banks look to sell assets on behalf of companies (hence they are often referred to as ‘sell-side’), whereas asset managers look to buy from or through investment banks (so they are often referred to as the ‘buy-side’).
Other areas that investment banks commonly get involved in include restructuring of companies and the offering of investment advice.
So, we’ve covered that investment banks are often referred to as the ‘sell-side’, investment managers on the other hand, are referred to as the ‘buy-side’. This is useful for understanding, at a basic level, the difference between the two areas.
What do investment managers do?
Put simply, investment managers look to invest clients’ money with the aim of making a return on it using their expertise.
Clients’ money is pooled into funds which are invested in various asset classes and run by defined strategies.
Who uses investment managers?
Investment managers generally look to serve two types of clients:
1. Institutions that have pools of assets / cash that they require a return on - for example, insurance companies, pension funds, corporates.
2. Retail investors, or individuals who typically invest via pooled funds which may be sold directly by the investment manager or through an intermediary - an investment platform or Independent Financial Advisor for instance.
Some of the attraction of investment managers to companies is the access to more investment options and expertise, as well as diversification, which would be more difficult to achieve on one’s own.
Active and passive
At a basic level, the techniques that investment managers employ with funds can be broken down into two styles:
1. Active: this is where investment managers look to outperform their benchmark, or an index that the fund will compare its performance against. In jargon terms, when it has outperformed its benchmark it is often referred to as alpha.
2. Passive: this is where investment managers look to track the fund’s benchmark. This is often referred to as “index-tracking”, as the fund’s benchmark is often an index – which the fund looks to mimic.
Generally, due to their active nature, active funds will have a higher management fee, but have the potential for higher returns; passive funds, on the other hand, tend to have lower management fees, but sometimes lower potential return.
View the original article on MoneyLens. MoneyLens is a website aimed at helping millennials manage their money.