Discretionary Investment Management: Definition, Benefits, Risks & Services

What Is Discretionary Investment Management?

Discretionary investment management is a service provided by a portfolio manager who makes investment decisions on behalf of an investor. The client and manager agree to a strategy and risk level, which gives the manager authority to execute trades without the need for approval. These services are usually offered to wealthy individuals or large institutions and often require a high minimum investment. The manager uses their expertise to grow and protect the client’s money, making choices that fit the client’s goals.

The Role of Discretionary Investment Managers

Discretionary investment services cater to high-net-worth individuals and institutional investors, requiring minimum investments of $250,000.

The investment manager’s strategy may involve purchasing a variety of securities in the market, as long as it falls in line within the client’s risk profile and financial goals. Discretionary managers might buy stocks, bonds, ETFs, and financial derivatives.

Discretionary Investment Management: Process and Client Considerations

Discretionary managers use a systematic approach, simplifying result reporting and executing strategies uniformly. Investments align with clients’ overall strategies, not individual customization. In other words, clients are grouped according to their highlighted goals and risk tolerance. Each group will then have the same investment portfolio created from the pool of money deposited by the clients. The actual client account is segregated and the funds invested are weighted to the individuals’ capital investments.

For example, consider a portfolio with an initial capital of $10 million. A high-net-worth individual that contributed $1 million will be said to have a 10% investment in the portfolio, while another that contributed $300,000 will have a 3% investment in the portfolio.

Advantages of Discretionary Investment Management

Discretionary investment management offers several benefits to clients. It frees clients from the burden of making day-to-day investment decisions, which can arguably be better made by a qualified portfolio manager who is attuned to the vagaries of the market. By delegating to a skilled manager, clients can focus on other important matters.

Investment managers align their interests with clients by charging a percentage of assets managed. As the portfolio grows, the manager earns more due to higher management fees. This reduces the adviser’s temptation to “churn” the account to generate more commissions, which is a major flaw of the transaction-based investment model.

Discretionary investment management may also ensure that the client has access to better investment opportunities through the portfolio manager. The client may also receive better prices for executed trades, as the portfolio manager can put through a single buy or sell order for multiple clients. For clients in discretionary accounts, portfolio managers can act on available information quickly and efficiently, selling the position out of all their accounts in a single, cost-effective transaction. Likewise, the portfolio manager is better positioned to seize buying opportunities when the markets dip and a good quality stock temporarily drops in value.

Potential Drawbacks of Discretionary Investment Management

However, high fees and account minimums can deter new investors. A new investor with a small amount to invest would not be able to benefit from this style of investment.

Clients must trust in the manager’s competence, integrity, and reliability. It is therefore incumbent upon clients to conduct adequate due diligence on potential portfolio managers before entrusting them with their life savings. There is a risk of entrusting money to a portfolio manager who is either unscrupulous or pays little heed to a client’s stated goals.

The Bottom Line

Discretionary investment management happens when a portfolio manager makes investment decisions for a client, making trades without needing approval each time. It’s often used by people with significant wealth, since it saves time and gives them access to professional strategies. While it can offer better opportunities and align the manager’s goals with the client’s, it usually comes with high fees and requires a large minimum investment. Because of this, it’s not the best option for new or smaller investors. If you’re considering it, you should do your due diligence and choose a manager you can trust.