​Investment - Direct and Indirect Investment

The enormous diversity of financial services and products available reflects the many varied requirements and issues clients encounter. Understanding the products and how they are organized supports an appreciation of how the investment sector delivers value for its clients. It also helps sharpen your awareness of how investment professionals may be assisted and how your contributions to the value creation process can be actualised.

Investment vehicles are any investment that can be made with the idea that by putting their money to work, the investor will enjoy some combination of a gain in the value of their money and a stream of cash flows. They may be formed with securities, such as shares, bonds, and warrants; real assets, such as gold, and real estate; or vehicles that combine wholly other investments.

Investors make direct investments when they acquire securities issued by firms and governments, and when they buy real, tangible assets, such as precious metals, art, real estate, or timber.

A typical approach to invest is through indirect investment vehicles. That is, investors send their money to investment firms, which subsequently invest the money in a variety of securities and assets on their behalf. Thus, investors make indirect investments when they acquire the securities of, or pay into, businesses, trusts, and partnerships that make direct investments. The following are instances of indirect investment vehicles:

Shares in mutual funds and exchange-traded funds
Limited partnership stakes in hedge funds
Asset-backed securities, such as mortgage-backed securities

Most indirect investment vehicles are pooled investments (also known as collective investment plans) in which participants pool their money together to enjoy the advantages of being part of a bigger group, with the pooling mediated by an investing professional. The associated economies of scale can greatly boost investment returns.

Both direct and indirect investments have advantages and disadvantages that investors need to assess. Direct investments have some advantages over indirect investments

Advantages of Direct Investments: -More control over decisions about investments -Manage to limit tax liabilities -Ability to select particular assets -High-quality guidance at a lesser cost for high-net-worth investors

Professionally managed -Small investors can use services of professional managers who they otherwise might be unable to afford -Share in the purchase and ownership of significant assets -Diversified portfolio -Less expensive to trade

Direct Investments
Investors exercise more control over direct investments than over indirect investments. Investors who hold indirect assets normally must accept all decisions made by the investment managers, and they can rarely have influence into such decisions.

Investors select when to buy or sell their direct investments to limit their tax responsibilities. In contrast, although the managers of indirect investments generally aim to limit the collective tax liabilities of their investors, they cannot simultaneously effectively serve all investors when their investors confront various tax circumstances.

Investors can choose not to invest directly in particular securities – for example, in stocks of companies that sell tobacco or alcohol. In contrast, indirect investors worried about such risks must choose investments with investment rules that include these limits.

Investors who are wealthy can typically acquire high-quality financial advice at a lesser cost when investing directly rather than indirectly.

Indirect Investments
Indirect investments are professionally managed. Professional management is particularly vital when direct investments are hard to find.

Indirect investments allow small investors to employ the services of expert managers, whom they otherwise could not afford to pay.

Indirect investments allow investors to join in the acquisition and ownership of major assets, such as skyscrapers. This benefit is especially crucial to small investors who cannot afford to buy huge assets directly.

Indirect investments allow investors to hold diversified pools of risks and so receive more reliable, but not necessarily greater, investment returns. Many indirect investment vehicles indicate ownership in many different assets, each of which normally is exposed to specific risks not shared by the others.

For example, a risk of investing in home mortgages is that the homeowners may default on their debts. Defaults on individual mortgages are highly unexpected, which makes keeping an individual mortgage quite dangerous. In comparison, the average default rate among a large sample of mortgages is significantly more predictable. Investing an amount in shares in a large mortgage pool is substantially less hazardous than investing the same amount in a single mortgage.

Indirect investments are often much less expensive to trade than the underlying assets. This cost benefit is especially significant for publicly traded investment vehicles that own very illiquid assets (i.e., cannot be acquired or sold fast without a considerable compromise in price).

Liquidity is one of the benefits of real estate investment trusts compared with real estate limited partnerships or real estate equity funds.Although the assets in which traded investment vehicles invest may be difficult to buy and sell, ownership shares in these vehicles can trade in liquid markets.

Is direct or indirect investment more profitable for investors?
It depends. Each investor and each investing firm must decide on the appropriate method given their individual demands and circumstances.

Investment Control Problems
Although the majority of investment managers strive faithfully to serve their clients, some are not always careful, attentive, or honest, which can lead to investment losses from inadequate research, lost opportunities, self-serving advice, or blatant fraud.

Insufficient Due Diligence
Investment managers who do not undertake sufficient research or due diligence may advise improper investments. Consider the scenario of a manager who buys a stock for a client portfolio purely based on the recommendation of a friend. It would be unacceptable for the manager to buy the stock without first completing full study and due diligence on the company.

Churning
Investment managers that receive commissions on trades that they recommend may conduct too many trades. Some managers have been known to sell and replace their whole portfolios once or more over the course of a year. Practitioners term this practice churning.

Self-Serving Managers
Investment managers may privilege themselves or their preferred clients above other clients when allocating trades that have been, or are likely to be, successful. For instance, a management might issue shares in an initial public offering that is projected to do well solely to preferred clients.

To successfully use the services of professional investment managers, investors must anticipate such challenges. Investors who do not wish to deal with these concerns sometimes prefer indirect investment vehicles, such as public mutual funds, for which a board of directors (or trustees) has main responsibility for monitoring the performance of the managers.

Although board members normally work honestly on behalf of their shareholders, some may be more devoted to the management they monitor than to the owners that they represent. Regardless, mutual fund managers often work hard for their investors. They are normally paid in proportion to the value of assets under management. Good performance draws further investors and serves to enhance their fees.

In contrast, large institutional investors are frequently direct investors who hire and oversee investment managers. These institutional investors can typically commit large resources to monitoring and appraising their managers.