What Is an Investment Management Agreement?

An Investment Management Agreement (IMA) is a formal document that sets the framework for the relationship between an investor and an investment manager. It outlines the specific responsibilities and expectations for both parties involved in the investment process, establishing clarity on the scope of services the manager will provide. This agreement creates a structured and transparent environment for managing investments, ensuring the investor’s financial goals and the manager’s operational procedures are aligned.

Defining an Investment Management Agreement

An Investment Management Agreement is a legally binding contract between an investor (client) and an investment manager or firm. It formalizes the terms and conditions under which the investment manager will oversee and manage the client’s financial assets, establishing the responsibilities, authorities, and limitations of each party. The agreement identifies the specific individuals or entities involved, including legal names and contact information.

A key aspect detailed within the IMA is the manager’s authority, which can be either discretionary or non-discretionary. With discretionary authority, the investment manager can make investment decisions, such as buying and selling securities, on behalf of the client without seeking prior approval for each transaction. Conversely, non-discretionary authority means the manager must obtain the client’s consent before executing any trades or making significant investment decisions.

This agreement is necessary for establishing trust, outlining responsibilities, and providing legal protection by defining the scope of the relationship. It also helps mitigate potential conflicts of interest. Investment advisors operate under a fiduciary duty, meaning they are legally obligated to act in the client’s best interest and prioritize the client’s needs. This duty requires full and fair disclosure of all material facts that could affect the advisory relationship.

Essential Components of an Investment Management Agreement

An Investment Management Agreement details various clauses that govern the investor-manager relationship. Key components include:

Scope of Services: Specifies the activities the investment manager will undertake, ranging from general portfolio management to specialized services. This includes the frequency of portfolio rebalancing and the types of securities the manager is authorized to trade.
Investment Objectives and Risk Tolerance: Defines the client’s financial goals, investment horizon, and acceptable level of risk, ensuring the manager’s strategy aligns with expectations. Performance benchmarks may also be specified to evaluate the manager’s success.
Fees and Compensation: Details the fee structure, such as asset-under-management (AUM) based fees, hourly rates, or performance-based compensation. The IMA specifies how fees are calculated, billing frequency, and the method of deduction from the client’s account. For instance, AUM fees commonly range from 0.25% to 1.50% annually.
Reporting and Communication: Describes how the client will receive updates on their investments, including the frequency and format of performance statements, account statements, and tax documents like IRS Form 1099. It also establishes preferred communication channels for ongoing dialogue.
Authority and Limitations: Defines the extent of the investment manager’s discretion over the client’s assets. If the manager has discretionary authority, the agreement will specify any restrictions or prohibitions on certain investments or trading activities imposed by the client.
Custody of Assets: Clarifies that client assets are held by an independent third-party custodian, such as a major brokerage firm or bank. The IMA confirms the investment manager’s role in directing trades to this custodian, but states that the manager does not directly hold the client’s funds or securities. Brokerage arrangements detail how the manager selects brokers for executing trades, emphasizing the responsibility to seek “best execution” for client transactions.
Confidentiality: Protects the client’s personal and financial information. These provisions restrict the manager from disclosing sensitive data to unauthorized third parties, except as required by law or for necessary business operations.
Termination and Dispute Resolution: Outlines the conditions under which either party can end the agreement, including required notice periods, often 30 to 90 days, and procedures for asset transfer. The agreement designates the governing law, typically the laws of a specific state, and methods for resolving disputes, such as arbitration or litigation.

Establishing and Managing Your Agreement

Establishing an Investment Management Agreement begins with initial discussions and due diligence. Prospective clients engage in consultations with investment managers to assess their services, investment philosophies, and fee structures. This phase helps determine if there is a suitable alignment of goals and expectations.

Once a manager is chosen, the process moves to the negotiation and review of the IMA. While many agreements are based on standard templates, specific terms related to fees, investment guidelines, and reporting can be negotiated. Clients should thoroughly review the entire agreement, seeking clarification on any unclear provisions, and consider consulting with legal counsel before signing.

Executing the document involves signing the Investment Management Agreement. This action legally binds both the investor and the investment manager to the outlined terms and conditions. Each party should retain a copy of the signed agreement for their records.

Managing the agreement requires periodic reviews to ensure it continues to meet the client’s evolving financial objectives and circumstances. Annual reviews are common, providing an opportunity to discuss portfolio performance, reconfirm risk tolerance, and make any necessary adjustments to the investment strategy. Amendments to the agreement, such as changes to investment guidelines or fee schedules, are made through formal written addendums mutually agreed upon by both parties.

The termination process follows the procedures specified in the agreement. This involves providing written notice within the stipulated timeframe. The IMA also details the steps for transferring assets from the current manager to a new custodian or back to the client.