This post looks at financial institutions, ethics, client advice, and taxation within the investment management industry. This is a great read for anyone thinking about investing their own money into the financial market as it will explain the basic concepts and give you an insight into what investment managers look for when advising clients.
Financial Markets and Institutions
In order to invest in financial markets, one must first understand what financial institutions do and how they allocate capital to the global economy. The financial service industry provides four main functions to the economy:
- Financial intermediation – enabling funds to transfer between lenders and borrowers.
- Pooling and managing risk – providing tools for risk to be managed through investment funds, insurance, and derivative products.
- Payment and settlement services – operating mechanism for money and other assets to be managed, transmitted and received.
- Portfolio management – allowing investors to manage their wealth through access to financial markets.
These four aspects of financial services together create the foundation for modern banking and are the stepping stones in understanding the basic principles of financial institutions.
A central bank sets the monetary framework which the economy and financial institutions operate. Financial intermediation involves the transfer of funds between surplus and deficit agents. These funds become liabilities because the institution lends them as direct loans or investments, to borrowers. In return, they charge interest rates, which is then passed to the original investor. The bank takes a slice of the action and works on this basic principle. In order to pay an investor their original investment if needed the bank keeps a certain amount of funds in assets that have a high liquidity. liquidity is the ability to sell a security without causing a significant movement in its price but also being able to sell an asset quickly in order to gain the cash. Highly liquid assets are very attractive to investors due to the ability to sell the investment quickly.
Ethics and Regulation
These markets are regulated by the Financial Conduct Authority (FCA) who is responsible for regulating the conduct of business. The FCA has three main objectives: consumer protection, protect the integrity and create competition. Alongside the FCA the Prudent Regulation Authority (PRA) aims to promote safety and soundness of the firms (insurance and investment companies) it regulates.
Ethics within the financial service industry has been widely publicised since the 2008 recession due to public distrust in financial services. The code of ethics followed sets out seven main categories: Professionalism, the integrity of capital markets, duties to clients, duties to employees, investment analytics and action, conflicts of interest and responsibilities as a CFA Institute member.
Client Advice
Advice for people thinking about investing money in financial markets must follow certain procedures. Firstly, the investment manager should explain the risks associated with investing. Secondly, the investment manager should tailor the investments to suit the client’s needs above all else. This comes in the form of three categories: the client’s time horizon – the longer the investment horizon the less need for liquidity, therefore, more risks can be taken. Return on investment – the clients expected returns on investments are key to where the client’s money will be invested, if for retirement long-term assets, if for a new car short-term assets. Risk tolerance is important as it depends on the client’s phycology and risk appetite. Other factors such as religious or ethical restrictions are playing a more important role in recent years for where investor funds are placed. Studies have shown that asset allocation has become more important than market timing. Investment managers need to ensure investors needs are met drawing on time horizon, liquidity needs, taxation and legal perspectives.
Tax
Taxation has always been an important factor when investing. Often investors try to allocate funds to the most tax efficient investments. This should not get confused with tax evasion. Tax avoidance is the legal structuring of tax affairs to ensure the lowest possible tax bill. whereas tax evasion is the deliberate action on part of the taxpayer to evade paying the proper or full amount of tax due. The main savings accounts to look out for are, individual savings accounts (ISAs), which have a tax free allowance of £20,000. These come in two types either cash ISAs which offer small returns or stock and share ISAs which enable money to be invested in shares and investments. For people starting to save money for the future, ISAs are a great way to start. For more serious investors venture capital trusts, real estate investment trusts, life insurance funds, and enterprise investment schemes are the better options due to the larger amounts of money that can be invested and the tax breaks offered.
Investment Weekly 