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By Mike Ross, Pie Funds
Accessing the stock market in different ways
Brokers, equity research analysts, fund managers, investment bankers... If you don’t work in the industry, knowing who does what in financial markets can be hard. But if you’re considering investing in the stock market, it’s important to understand who is managing your money.
So, you want to invest in the stock market?
If you’re not a professional investor, and you want to dip your toes in the water, then you have three main ways of doing this. You can invest your money with a fund manager, open an account with a stockbroker, or use a financial adviser. But which one is best for you?
Three ways to access the stock markets
When you invest with a fund manager, you receive units in a pool of money (the fund), which is managed by a team of analysts and portfolio managers. The fund manager’s job is to find attractive investments to put their clients’ money into. The fund could invest in shares, bonds, property, or a number of other asset classes. If these investments increase in value, so do the units you own in the fund.
When you invest with a fund manager, you’re giving the fund manager the freedom to manage your money, trusting their judgment and expertise. You will receive a monthly statement telling you how your units in the fund are performing, but you will not be told about every investment decision the manager makes on your behalf.
Stockbrokers operate differently. They will also buy and sell shares, but only with your permission. The choice of investment could be your idea, or it could be the broker’s. Over the past decade or so, online brokers have also emerged, meaning people can invest in stocks without interacting with an individual.
You can also access the stock market through a financial adviser. After assessing your circumstances, the adviser will typically design an investment portfolio across an array of asset classes. This will usually include exposure to equities either through a fund manager, or sometimes the adviser will be able to buy and sell individual shares on behalf of the client.
To do the latter, the adviser or broker must hold a discretionary investment managed services (DIMS) licence. In 2016 most stockbrokers are also investment advisers, meaning they can advise you to make a specific investment and then execute the trade. However most advisers are not stockbrokers.
Choosing between a fund manager, financial adviser or broker
People usually choose to invest with a fund manager or a financial adviser because they lack the time or expertise to identify and manage investments themselves. They prefer to outsource these tasks to a specialist.
All fund managers publish past years’ investment returns for their funds. A good track record may give you confidence in the fund manager’s continued success. But remember, past performance is not indicative of future returns.
People who elect to invest through a broker might want more input into the investment process. If you have a natural interest in looking for investments, or believe you have certain insights that make you a good stock-picker, then a broker allows you to be the decision-maker. Unlike a fund manager or financial adviser, using a broker gives you complete responsibility for where your money is invested.
The price you pay
‘Money makes the world go round’, is a saying that rings especially true in the world of finance. So you should also consider how the fund manager, financial adviser or broker managing your money is paid.
A fund manager is compensated in two ways – a ‘management fee’ and a ‘performance fee’. The management fee is a percentage of the money you have invested in the fund, usually less than 2 per cent. The performance fee tends to be the higher of the two, and is subject to the fund outperforming a benchmark nominated by the fund manager. That benchmark could be a market index or the Official Cash Rate (OCR). The OCR is the rate of interest the Reserve Bank charges on overnight loans to commercial banks.
The benchmark could also be based on absolute return, meaning the fund needs to deliver a positive return for the manager to be paid a performance fee. Some funds include a ‘high watermark’, meaning the performance fee is only paid if the fund is at its highest historical value at the end of the period.
Stockbrokers are paid a ‘commission’ each time they buy and sell a share on behalf of a client. This is normally a fixed percentage of the value of each trade. Brokers don’t usually charge a performance fee. They will often ‘pitch’ a stock or investment idea to a client, who then decides whether to act on the broker’s advice.
A financial adviser is usually compensated in two ways. They charge clients a fee for their services and they may receive commissions from providers of financial products. There are strict rules requiring advisers to disclose commissions to their clients given the potential for conflict of interest.
Growth for growth’s sake
A fund manager’s fees are structured as an incentive to deliver attractive returns for investors.
However, when picking a fund manager you should also keep in mind the exceptions to this rule. For instance, some larger fund managers have been criticised for growing for growth’s sake. Remember, the management fee is a percentage of the fund. This means a large funds-management business can be very lucrative, without necessarily delivering desirable returns for its investors.
Another point to consider is whether the fees charged by a fund manager match the returns the fund achieves. People often focus on the fees charged by a fund and say they’re too dear, when they should really ask if the fund’s performance justifies those fees.
A fund with higher fees, but a history of outstanding returns, could be preferable to a cheaper fund offering subpar returns. After all, your total investment returns should be much higher than the fee charged by the fund manager.
Big is not always better
Another consideration when choosing a fund manager is the size of the fund. The number of outstanding investment opportunities out there is limited, so as an investment fund accumulates more money, it naturally becomes more difficult to continue generating attractive returns. This is why many successful smaller fund managers limit their funds under management.
Many fund managers also require their employees to invest in the funds and staff are prohibited from making outside investments. This means the people managing your money are invested alongside you and their interests are aligned with yours.
Stockbrokers’ compensation, on the other hand, is tied to the volume of shares traded, not the success of the investment. At face value, this means the broker’s interests are not necessarily aligned with their client’s, because they are paid the same amount whether the investment makes money or not.
However, relationships are key in the brokerage business and keeping clients is a priority. The broker should be acutely aware that they will lose their client’s business if their investment ideas continually fail to generate attractive returns.
Making the right choice
Whether you decide to invest with a fund manager, financial adviser, a broker, or not at all comes down to your personal circumstances. You must understand who you are trusting to manage your hard-earned cash and what their incentives are.
Do the research to find a money manager with a good track record and an approach to investing that feels right for you.
AT A GLANCE
• Fund managers:
- Invest money on behalf of a client within agreed guidelines e.g. shares or bonds
- Seek to find attractive investments for clients
- Receive a management fee and sometimes a performance fee
- Buy and sell shares directed by a client
- Can be online brokers or traditional (person)
- Are paid a commission each time they buy and sell a share
• Financial Advisers:
- Can access stock market investments for their clients by using a fund manager.
- Can buy and sell individual shares on behalf of a client as long as they hold a discretionary investment managed services (DIMS) licence.
- Are paid a client fee for their services and may receive a commission from providers of financial products.