In a previous article, we introduced the CFA Institute Investment Foundation Program (Read more here). It is a free program designed for anyone who wants to enter or advance within the investment management industry, including IT, operations, accounting, administration, and marketing. Candidates who successfully pass the online exam earn the CFA Institute Investment Foundations Certificate.
There are total of 20 Chapters in 7 modules, covering all the essential topics in finance, economics, ethics and regulations. This series of articles will highlight the core knowledge of each chapter.
Chapter 16 provides an overview of the investors and their needs. The learning outcome of chapter 16 is as follows:
· Describe the importance of identifying investor needs to the investment
· Identify, describe, and compare types of individual and institutional investors;
· Compare defined benefit pension plans and defined contribution pension plans;
· Explain factors that affect investor needs;
· Describe the rationale for and structure of investment policy statements in serving client needs.
The investment industry provides a range of services—including financial planning, trading, and investment management—to a wide variety of clients. Individual investor clients range from those of modest means to the very wealthy. The investment industry also provides services to many types of institutional investors, such as pension funds, endowment funds, and insurance companies. Because investors are all unique, it is important to understand each of their specific circumstances in order to best meet their financial needs. It is not possible to act in a client’s best interests if those interests are not understood and incorporated into the chosen investment strategy.
Clients differ in terms of their financial resources, personal situations (if they are individual clients), objectives, attitudes, financial expertise, and so on. These differences affect their investment needs, what services they require, and what investments are appropriate for them. For example, elderly clients with significant resources may be very concerned with estate (inheritance) planning, but elderly clients with modest resources may be more concerned about outliving their resources. A shortfall in investment returns may have significant consequences for the latter but have less impact on the former.
Individual investors are often differentiated based on their resources. Most will have relatively modest amounts to invest. Other, more affluent individuals will have larger amounts. The term “retail investor” can be used to refer to all individual investors, but it is common to use the term to refer to individual investors with modest resources to invest.
Many investment firms make a distinction between their retail clients, more affluent clients with larger amounts, and high- and ultra-high-net-worth investors with the largest amounts of investable assets.
Retail investors are by far the most numerous type of investor. They buy and sell relatively small amounts of securities and assets for their personal accounts. They may select investments themselves or hire advisers to help them make investment decisions. They also may invest indirectly by buying pooled investment products, such as mutual fund shares or insurance contracts.
The investment industry provides mostly standardised services to retail investors because they generate the least revenue per investor for investment fi rms. Many retail investment services are delivered over the internet or through customer service representatives working at call centres.
Wealthier investors or high-net-worth investors, generally receive more personal attention from investment personnel. Their investment problems often involve tax and estate planning issues that require special attention. They either pay directly for these services on a fee- for- service basis or indirectly through commissions and other transaction costs.
Very wealthy individuals or ultra-high-net-worth investors usually employ professionals who help them manage their investments, future estates, and legal affairs. Th ese professionals often work in a family office, which is a private company that manages the financial affairs of one or more members of a family or of multiple families. Many family offices serve the heirs of large family fortunes that have been accumulated over generations. In addition to investment services, family offices may provide personal services to the family members, such as bookkeeping, tax planning, managing household employees, making travel arrangements, and planning social events.
Wealthy families often have substantial real estate holdings and large investment portfolios. Th e investment professionals who work in family offices generally manage these investments using the same methods and systems that institutional investors use. They pay especially close attention to personal and estate tax issues that may significantly affect the family’s wealth and its ability to pass wealth on to future generations or charitable institutions.
Institutional investors are organisations that hold and manage portfolios of assets for themselves or others. Th ere are many different types of institutional investors with varying investment requirements and constraints. Institutional investors may invest to advance their mission or they may invest for others to meet the others’ needs. Institutional investors that invest to advance their missions include pension plans, endowment funds and foundations, trusts, governments and sovereign wealth funds, and non- financial companies. Institutional investors that invest to provide financial services to their clients include investment companies, banks, and insurance companies.
Defined benefit pension plans promise a defined annual amount to their retired members. The defined amount typically varies by member based on such factors as years of service and annual compensation while employed. Typically, employees do not have the right to receive benefits until they have worked for the company or government for a period specified by the pension plan. An employee’s rights are vested (protected by law or contract) once they have worked for that period.
In a defined contribution pension plan, the pension sponsor typically contributes an agreed- on amount—the defined contribution—to an account set up for each employee. Employees also generally contribute to their own retirement plan accounts, usually through employee payroll deductions. Th e contributions are then invested, normally in funds that the employee chooses from a list of eligible funds within the plan. Th e plan provides enough choices of funds to allow employees to create a broadly diversified portfolio. Th e sponsor generally limits the choices to a set of mutual funds sponsored by approved investment managers. Th e pension plan sponsor should also ensure that the fees charged on the funds are reasonable. At retirement, the balance that has accumulated in the account is available for the employee.