As the subject of investment becomes more popular, many people wonder: what’s the difference between investment banking and investment management? In this article, we will observe their features and compare.
Investment banking in general
Investment banking is not just a direction in the financial market, but a whole institution that is necessary for the development of services provided by financial institutions. The close relationship between the various banks of different states and the world economy as a whole is undeniable. Awareness of this relationship made it possible to take a fresh look at the already familiar category of financial capital.
Banks and other financial institutions have always treated business investment proposals favorably, especially if this business is profitable and promises considerable benefits from participating in it. However, shareholders and investors need to be able to correctly and quickly respond to the ever-changing conditions of the financial market. This means that investors need a solid foundation that can protect their investments from the activities of dishonest traders and the influence of shadow systems. Those organizations that do not neglect the methods of shadow activity, as a rule, fail at the first difficulties of mass shortages.
In order to carry out investment banking, it is necessary to prioritize. For an organization, the main things may be profit, reliability, long-term deposits (which is suitable for capital preservation), and liquidity — the ability to quickly sell securities at market price. Each bank has a certain amount of investment. The totality of all funds invested somewhere is called the investment portfolio of a banking organization. Deposits of funds by banks have their own nuances and features, without which there can be no question of successful investment activity.
Investment banking involves:
- observance of certain regulatory legislation, which prescribes norms and restrictions on investments,
- an extremely high risk of not receiving income or not receiving it in full. Since banks invest their own funds, the risk of not receiving some amounts or simply losing them during a crisis is quite large;
- urgent nature of bank liabilities.
As already mentioned, there are certain risks associated with investing in general, and especially with banking. These factors include:
- Investment risk factor. This is the risk associated with a sharp drop in the value of the securities of a particular company.
- Credit risk. This risk factor takes into account the bank’s lending performance and is defined as a decrease in the flow of credit funds into the bank’s capital.
- Interest risk. Here the main danger is a change in the interest rate. These risks are specific to the investment activities of the bank. These are unstable factors that cannot be completely eliminated.
The most common direction of investment and banking activity is the financing of corporations. Investments in the form of loans are provided to various companies for internal or external development, as well as to expand their capabilities. Such financial assistance is necessary for those companies that develop in an atmosphere of absolute and fierce competition. For example, a company needs to increase its revenues, and to do this, it will have to conduct a lot of research and advertising campaigns in order to obtain data on the level of demand for its product or service from potential customers. Subsequently, the company will rely on these indicators in the formation of a long-term financial policy. But the problem is that the costs of advertising campaigns and research are very high. It is for this that the services of investment banking structures are used.
Another area in which the investment capacity of financial organizations is actively used is the mergers and acquisitions of some companies by others. For example, one large company that occupies a leading position in its field wants to expand its influence by purchasing another company. In this case, the financial institution must conduct a series of studies in order to make its predictions about the benefits of such a transaction, and then make a decision to provide funds or not. In this case the bank acts as a mosaic provider. The main condition for such a merger should be mutual benefit, both for the company that absorbs, as well as for the one that was absorbed. Only then will they be able to dominate in their field.
It should be noted that both companies benefit from the merger procedure, regardless of what position they occupied in the market before. Investors who participate in such a transaction receive their profit.
Do not confuse an investment banker with a simple business loan. There is a significant difference between them. In the case of investment banking, the company that received the funds is free to use them as it sees fit.
As a rule, such areas of investment activity depend on the economic and political situation not only in the country, but also in the whole world. Financial institutions invest their funds only when they are sure that they will bring profit. In most cases, profits accumulate when shares of those companies where own funds have been invested are bought or sold. After making a profit, the participants in the transaction analyze their relationship. The result of this analysis determines whether the parties will continue to cooperate or terminate their partnership.
Main directions of investment banking
The main types of banks’ investment activities are as follows:
- Attraction of financing
- Advisory services on mergers and acquisitions of competing organizations
- Advice on possible ways to reorganize an existing business project
- Reorganization of an enterprise and its further sale
- Creation of a block of shares and its subsequent sale
- Drawing up an investment portfolio and its trust management
- Consultations and carrying out issues of the client’s securities
- Implementation of dealer operations with the client’s securities
- Implementation of brokerage operations/brokerage services
- Changing the share capital structure at the request of the client
- Consulting services
- Service of clients’ securities
- Depositary and custodial services
Investment banking is actively and dynamically developing. Customers need more tools to meet their needs. Based on these requests, banking organizations create new products. However, in general, it is possible to single out a group of services consistently provided by any investment bank.
The main areas of investment banking include:
- project financing (investment bank acts as a financial advisor),
- corporate financing (attracting a strategic investor, assistance and advice in mergers and acquisitions of other companies).
From the above activities, the bank can receive income in the form of:
- commission paid for investment services provided by the bank,
- interest on the bank’s funds provided for use,
- the difference between the purchase price and the sale price of the security in which the bank investments were made.
Problems of investment banking
The problems of development of investment banking include:
- predominance of “short” and unstable liabilities,
- high level of credit risk.
One way to solve the first two problems could be to increase the interest rate on long-term deposits. A bank provides depositors with long-term investment additional benefits in the form of the opportunity to use accrued interest, offering the highest interest rates. The benefit for the bank here will be the opportunity to use the funds raised in long-term projects.
Another solution to this problem is the use of Internet banking. It is attractive for both individuals and organizations, as managing their account from electronic devices (even a mobile phone) will simplify their task and save time.
It should be noted that in recent years there has been a positive trend in the structure of liabilities of commercial banks. In the structure of liabilities of the banking sector, there has been a trend towards replacing the funds of the State Bank with market sources (primarily deposits of individuals).
Many authors believe that attracting the real sector to obtain bank loans depends largely on the actions of public authorities. Of course, much depends on the political situation in the country, on the level of legislation, what mechanisms the state uses to support entrepreneurship and banks, and so on. But the banks themselves play an important role in attracting the real sector of the economy.
In order for banks to be able to pay more attention to lending to the real sector of the economy, it is necessary to solve the problem of banking risks. Banking risks can be divided into external and internal. External risks (inflation, decrease in market liquidity, etc.) do not depend on the activities of the bank itself or its clients; internal risks (interest rate, currency, price, etc.) are associated with the inability to fully control the activities of bank customers.
Thus, solving the problems of the development of investment banking will make it possible to intensify the investment activities of commercial banks, thereby launching the effective production activities of enterprises.
Investment management in general
Investment management is a set of methods, techniques, and principles that allow you to effectively manage the processes of investment and cash flow in order to obtain a stable income. It acts as an integral part of the overall management.
Management activities that are directly related to investment processes are carried out at several hierarchical levels. If we remember about micro- and macroeconomics, then we can easily list those levels where an asset manager must be involved. We are talking about states, subjects of the federation, municipalities and individual enterprises.
It is quite natural that at each of the listed levels, investment activity has its own specifics and features. However, at the same time, such management, regardless of where it is carried out, is based on the same principles and methods, and also solves similar problems.
Main functions of investment management
Investment management has three main functions:
Each of them has a telling name. However, let’s take a closer look at them.
The planning function of management refers to the initial stage of the investment process. It characterizes the competent development of the only true strategy for investing money. This is where the investment policy is being formed. Without its implementation, it is impossible to correctly build the activities of an enterprise, municipality or country, as well as to make it sufficiently reliable and sustainable in the long term.
The organizational function of management refers to the stage of direct alignment of the investment project. Here, investors should decide on many of the most important issues, without which it will be impossible to further implement the developed strategy and policy of the investment subject. In particular, we are talking about identifying needs for raising funds from external sources, finding a strategic partner and investor, choosing investment instruments, building an investment portfolio, and other activities. It is very important to note that such tasks can and should be automated with the help of programming languages and frameworks (for example, Node.js, query string, and others). Automation helps to avoid cases with undefined performance and unclear results of investment.
At the same time, the investment activity of an economic entity should be at a level that best suits the chosen development strategy of the company.
The coordinating function of management refers to the stage of direct implementation of the developed and agreed project. Investment managers must constantly monitor and coordinate all actions and activities aimed at achieving their goals, they are kind of a provider base for your asset management. If violations and shortcomings are identified, specific decisions should be made to introduce changes to the project that will neutralize and compensate for the shortcomings.
Goals and objectives of investment management
Investment management should perform the following tasks:
- ensure the growth of production and economic indicators of the company,
- maximize the profitability of all investment objects,
- minimize the risks that always accompany the activities of the investor.
The main goal of such management is to choose investment assets (both traditional and alternative) that are optimal for the current economic situation. They should combine the highest possible profitability and the lowest level of risk, and moreover, this management must always be up to date, since exchange risk parameters change all the time.
Thus, we can understand investment management as a set of measures that are aimed at preserving and increasing the capital of an enterprise.
Investment management can be divided into several successive stages:
- development of tactics
- analysis of securities
- formation of an investment portfolio
- current portfolio adjustment
- analytical work on ongoing projects
The investment strategy should be developed taking into account all the goals that the investor plans to achieve with this investment. It is also necessary to consider the financial capabilities of the investor, the level of expected return on investment, and the existing level of risk. In order to determine the attractiveness of a project, we can use 2 types of analysis: technical and fundamental.
Conducting technical analysis involves constant monitoring of the stock market, as well as forecasting the price dynamics for individual assets. The main task of such an analysis is the timely determination of the growth trend in the value of an asset.
Conducting fundamental analysis involves familiarity with macroeconomic indicators. In order to determine the actual level of exchange risk parameters and the degree of expected profitability of an investment project, it is necessary to take into account:
- financial stability of the company,
- the liquidity of the asset,
Based on such indicators, the investor can determine the prospects for the long-term development of the enterprise. Based on this information, the final investment decision should be made.
Summarizing all of the above, we can say that investment banking is an increasingly prominent line of income in the overall structure of bank income. This type of activity provides a number of advantages: increased income, improved image and recognition, status. Therefore, there is every reason to develop it.
For the successful development of investment banking in a country, it is necessary to create conditions for the effective functioning of the subjects of the real economy, which will ensure a high demand for investment services in the future. In turn, this will have a positive impact on the development of the securities market, increasing its quality and volume. An important factor here will also be the development of competition in the financial and, in particular, in the banking sector. Ensuring fair competition will positively affect both the structure of investment services, and the quality of their provision, and the emergence of new investment products that meet the needs of the economy. Thanks to this, there is a real opportunity for the country’s economy to reach a fundamentally new level of economic development.
And investment management is just an area of methods and processes that help people involved in investment effectively manage their or company’s assets. Which means that actually there is no “investment management vs investment banking”, both can go hand in hand, collectively forming a system of asset management.