What is Investment Management Agreement (IMA)?

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An Investment Management Agreement (IMA) is an agreement between an investor and fund manager, where the fund manager agreed to manage the investment for the investor according to the objective and manner stipulate in the agreement. This agreement is formulate between an investor and the fund manager after rounds of negotiation with the help of legal adviser. 

The main component of IMA includes the investment objective/target, investment restriction, management fees for the fund manager, custody of the investment, valuation and reporting requirement. Like any other business contract it will also includes effective date of contract, duration of contract and condition of termination.

Listed below is some of the key component in the IMA:

Investment Objective / Target

Under investment objective, the investor will stipulate what is the investment objective and the target return. This is the most important component for the fund managers. For example, an investor can demand the fund manager to align the investment portfolio with an established benchmark; while allowing the fund manager a 20% deviation from the benchmark but the fund manager must have a return target of 2% above the benchmark. Therefore, if a benchmark has a 7% return, then the return target should be 9%. There are many types of investment objectives and target returns.

Investment Restriction

This component is very important not only to the fund manager but it is also important to all the operational staff including the traders. Any violation of the restriction may carry a heavy penalty. While the compliance officer will ensure the enforcement of investment restriction; it is usually too late because the trade has been done. The onus is mainly on the fund manager, fund management assistance and the trader to prevent from violating the restriction. Some companies even hire staff just to do pre-trade compliance. Listed below is some examples:

• No investment in xxx country
• No investment in tobacco and liquor stock
• Investment in xxx stock may not exceed x% in the portfolio
• Cash must be maintained between 2% to 5% of the portfolio

Management Fee

This is the income of the fund management firm. Besides the executives, the accounting staff must be aware of the fee so that fees can be accrued and deducted from the portfolio accordingly.

Custody of Investment

If you manage money for a pension fund, usually they will appoint a custodian bank to hold the investment portfolio including the bonds, stock certificates and cash. The custodian bank will also be representing the pension fund in annual shareholder meetings. Any stock splits and rights issue will also be managed by the custodian bank. A lot of central bank and monetary authority encourage such practice because it provides check and balance, and potentially prevent rouge fund managers from misusing the client's asset. Custodian bank has specific instruction to notify the investor if there is large movement of cash or stocks. In addition, the pension fund may ask the custodian bank to provide fund accounting and valuation services.

Valuation and Reporting Requirement

Valuation requirement stipulate how the investment portfolio be valued such as  the date of valuation, the exchange rate and who to provide the valuation. More sophisticated clients will require the valuation be done by the custodian and they  may request additional valuation report from the fund manager for comparison. The client may also stipulate the reporting deadline.

There are many components in an IMA, the items mentioned above are just some key components that are common. Not every IMA is the same and the investor may include anything under the sun as long as the fund manager agrees.

Usually the negotiation of IMA happens between the investor and some key executives of fund management firm. Those key executives includes the CEO, marketing manager and fund manager. Usually the operational staff is out of the loop until the agreement is signed. This presents some problem when the marketing managers promise everything the investor requires without considering whether if the operation staff could deliver those requirement. If the COO is not involve in the negotiation of IMA, it would be advisable to allows the COO to go through the final draft of the IMA to determine if his/her operation staff could deliver the requirement before the CEO sign the IMA.

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Process of Acquiring Institutional Investor

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Usually institutional clients will not investment money with a new and unknown investment firm. Institutional clients will monitor the investment firm’s track record for at least three years. It is the responsibility of the marketer of the investment firm to maintain relationship with a prospective institutional client and furnish investment performance report to the prospective client for review. The marketer also needs to present to the prospective client their investment philosophy and investment process. 

After three years of monitoring, if the institutional investor wants to invest with an investment firm, the client will contact the investment firm to request for investment proposal. After reviewing the investment proposal, the prospective client would proceed further into the next phase. 

During the second phase, the prospective client would study the investment process in more detail and scrutinize the investment performance report. Initial negotiation of fees and investment requirement will start in this phase. If the institutional client is satisfy with the preliminary finding and both parties agreed to the investment requirement and fees, both parties would proceed to the next phase. 

In the third phase, the prospective institutional investor and the investment firm will start negotiating and formulate an Investment Management Agreement. At the same time the institutional investor will perform their due diligence and examine the investment firm’s internal audit & control, compliance procedure, security measure and investment operation. The prospective investor will detail their investment restriction and operational requirement to the investment firm’s operational staff. Once the institutional investor is satisfied with the investment operation, it will proceed to finalize the Investment Management Agreement (IMA) with the management. 

Once the IMA is signed, the investment firm has secured the investment fund from the institutional investor.  The investment firm will receive money or securities from the investor at the stipulated date and invest the money according to guidelines lay out in the IMA.

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How does an Investment Firm get Investment Money?

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Disclaimer: As an Investment Technologist, I do not claim to be an expert in marketing. The following article is based on my observation while working for various investment firms.

An investment firm can source their clients from 3 main groups of people or organisation. It can find customer from institutional investor, individual retail investor and wealthy individual / family.

Wealthy Individual or Family

This is not a major venue for securing clients; however, some new or smaller investment firms welcome wealthy individual or family with a minimum investment amount of USD5 million. For larger investment firm, they may require the client to commit a minimum of USD100 million for investment. They would encourage their prospective client to invest in mutual fund for smaller investment commitment.

The only way to secure wealthy individual and family as client is through personal networking. Alternatively, the investment firm’s marketer can establish business relationship with private bankers. Although most wealthy individual trade through private bankers and private bankers also provides investment advisory; some wealthy clients may ask their private bankers to recommend them reliable investment firms and leave the management of money solely to the investment firm.

Retail Investor

An investment firm can setup a mutual fund and collect investment money from individual investors. It is very hard for small investment firm or new investment firm to attract retail investor without a proven track record and substantial investment fund. It requires a lot of resources to setup a mutual fund that conforms to the financial regulation. Therefore, only mid size or larger investment firms could afford to set up a mutual fund. Besides legal fees, the investment firm also needs to invest in  large sum of advertising dollars to attract investment from the public. The risk is high if the mutual fund fails to attract enough investment.

Institutional Investor

This is the main venue for most investment marketers to secure clients. Institutional investors includes pension fund, foundations, charity, trust fund, insurance company, sovereign investment arm or treasury department of a country, treasuries from society, trade associations, religious organisation and corporations that have a large cash reserves.

An investment firm’s marketer needs to establish relationship with these organisations through networking. Alternatively, the marketer can scan through trade journals or the websites of these organisations to look for investment opportunities. Some organisations will routinely post their investment requirement and request any investment firms to submit an investment proposal for their review.

Alternatively, the marketer can establish business relationship with reputable investment consulting firm. Some institutional investor would hire an investment consultant to help them to formulate investment strategy and evaluate investment firm. If an investment consultant like your investment approach, he/she would recommend you to many prospective clients.

A new investment firm without a proven track record would invest with their own money and money from wealthy individuals. Once a track record has been established, it is easier for them to secure clients from the institutional investors. Once the investment firm grows to a certain size, then it would proceed to seek investment money from the public. By then, they would recommend their wealthy individual clients to invest in mutual fund. Once an investment firm grows to a certain size, it is not cost effective to manage funds that are less than USD50 million.

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