The Strategic Implementation of an Investment Process in a Funds Management Firm

One of several important strategic decisions that have to be made by an active funds management organization is how aggressively it implements its investment process. In this paper we model this decision on the assumption that the organization’s objective is to maximise the present value of its future fee income. We then develop the model using numerical methods in order to demonstrate the impact of several endogenous and exogenous factors on this optimum active position. In particular we highlight that the most aggressive funds are likely to be embryonic funds that have the greatest potential to add value. We also establish that in the event that such funds increase their funds under management; it will be optimum for them to become more index-like. We demonstrate that the extent to which the implementation decision for the active process is a function of a number of factors including the alpha and risk characteristics of the active component of the portfolio, the risk tolerance of the promoting organization and the relationship between performance and future fund flows. Our findings have extensive implications ranging from the choice of investment managers by investors to the functioning of capital markets.