Question

What is a size of a typical investment management team? Why is employee turnover a “red flag” at an investment firm?

Answer 1

What Is a Red Flag?

A red flag is a warning or indicator, suggesting that there is a potential problem or threat with a company's stock, financial statements, or news reports. Red flags may be any undesirable characteristic that stands out to an analyst or investor.

Red flags tend to vary. There are many different methods used to pick stocks and investments, and therefore, many different types of red flags. So a red flag for one investor may not be one for another.

How Red Flags Work

The term red flag is a metaphor. It is generally used as a warning or a cause for concern that there is a problem with a certain situation. In business, there may be red flags that warn investors and analysts about the financial future and/or health of a company or stock. Economic red flags often suggest problems looming for the economy.

There is no universal standard for identifying red flags. The method used to detect problems with an investment opportunity depends on the research methodology an investor, analyst, or economist employs. This may include examining financial statements, economic indicators, or historical data.

Investors need to exercise due diligence when considering whether to make investments in a company or security. Financial statements provide a wealth of information about the health of an organization and can be used to identify potential red flags. However, identifying red flags is nearly impossible if the investor cannot properly read financial statements. Gaining a solid understanding of and being able to read financial statements helps ensure success when investing.

Some common red flags that indicate trouble for companies include increasing debt-to-equity (D/E) ratios, consistently decreasing revenues, and fluctuating cash flows. Red flags can be found in the data and in the notes of a financial report. A pending class-action lawsuit against the firm, which could compromise future profitability, is one red flag that is often found within the notes section of a financial statement.

A red flag for one investor may not be one for another.

Problems With Financial Statements

Red flags may appear in the quarterly financial statements compiled by a publicly-traded company's chief financial officer (CFO), auditor, or accountant. These red flags may indicate some financial distress or underlying problem within the company.

Red flags may not be readily apparent on a financial statement, so it may take further research and analysis to identify them. Red flags usually appear consistently in reports for several consecutive quarters, but a good rule of thumb is to examine three years' worth of reports to make an informed investment decision.

Corporate Red Flags

Investors can look at revenue trends to determine a company's growth potential. Several consecutive quarters of downward-trending revenue can spell doom for a company.

When a company takes on more debt without adding value to the business, the debt-to-equity ratio could rise above 100%. High debt-to-equity ratios raise red flags for investors. The perception may be that the company is not performing well and is too risky an investment since more creditors finance operations than investors.

Steady cash flows are indicative of a healthy and thriving company, while large fluctuations in cash flows could signal a company is experiencing trouble. For example, large amounts of cash on hand could mean that more accounts are being settled than work received.

Rising accounts receivables and high inventories may mean a company is having trouble selling its products or services. If not remedied in a timely fashion, investors will question why the company is unable to sell its inventories and how this will affect profits.

What Is Investment Management?

Investment management refers to the handling of financial assets and other investments—not only buying and selling them. Management includes devising a short- or long-term strategy for acquiring and disposing of portfolio holdings. It can also include banking, budgeting, and tax services and duties, as well.

The term most often refers to managing the holdings within an investment portfolio, and the trading of them to achieve a specific investment objective. Investment management is also known as money management, portfolio management, or wealth management.

The Basics of Investment Management

Professional investment management aims to meet particular investment goals for the benefit of clients whose money they have the responsibility of overseeing. These clients may be individual investors or institutional investors such as pension funds, retirement plans, governments, educational institutions, and insurance companies.

Investment management services include asset allocation, financial statement analysis, stock selection, monitoring of existing investments, and portfolio strategy and implementation. Investment management may also include financial planning and advising services, not only overseeing a client's portfolio but coordinating it with other assets and life goals. Professional managers deal with a variety of different securities and financial assets, including bonds, equities, commodities, and real estate. The manager may also manage real assets such as precious metals, commodities, and artwork. Managers can help align investment to match retirement and estate planning as well as asset distribution.

In corporate finance, investment management includes ensuring a company's tangible and intangible assets are maintained, accounted for, and well-utilized.

According to an annual study by research and advisory firm Willis Towers Watson and the financial newspaper Pensions & Investments, the investment management industry is growing. When based on the combined holdings of the 500 biggest investment managers, the global industry had approximately US$93.8 trillion assets under management (AUM) in 2018. This figure was over US $100 Trillion by year end 2019, but in the aftermath of the COVID-19 pandemic, the value of the holdings had significantly decreased.