What Is an Investment Mandate?
Guide Your Account or Fund According to Your Needs
An investment mandate plays an important role in managing pooled funds. Index funds have investment mandates. So do exchange-traded funds (ETF) and university endowment portfolios. Rich investors with their individually managed accounts have investment mandates, too. Mandates direct the managers of these investments and help guide their decision-making.
How Investment Mandates Are Used
An investment mandate is an instruction to manage a pool of capital—a particular pile of funds—using a specific strategy and within certain risk parameters. The mandate will vary depending on the goals the owner has for that money.
For example, if a client showed up to a wealth management firm and said, "I have $500,000 that I want to be kept safe so I can use it to put a down payment on an office building for my company later this year," the mandate would be called capital preservation.
The client wishes to preserve her capital; therefore, there would be a limited number of investments that could be considered when constructing a suitable portfolio. Volatile investments would be out of the question: You would not, for example, buy shares of intermediate-term bonds or even the most royal of blue-chip stocks because the time frame is so short it doesn't allow you to mitigate volatility risk.
The volatility of stocks means they would not be suitable for capital preservation, even if they would be suitable for a different mandate. For example, shares of a firm such as Johnson & Johnson, one of only four S&P 500 components with a Triple-A bond credit rating, should be worth considerably more money in 10, 15, or 25 years, but no one has any idea what they will be worth this year, which is the time frame your client has given you. That's the nature of the auction mechanism of common stocks, and it cannot be avoided. As the great financial thinker Benjamin Graham explained, in the short term, the stock market is a voting machine, reflecting popularity, but in the long-term, it's a weighing machine, reflecting intrinsic value.
You must tailor the portfolio and its components to the mandate; seeking capital preservation within a short time frame would indicate low-risk, low-volatility investments and cash holdings.
A Long-Term Growth Investment Mandate
If a client's goal is long-term growth, the portfolio manager must prioritize the long-term capital appreciation of the underlying securities over things such as current income or volatility risk. Stocks are a common investment holding for long-term growth; if the portfolio is down 30% tomorrow, it doesn't matter, because having a long-term investing horizon gives plenty of time for the market to recover and even improve.
An Income Investment Mandate
When an investor needs to live on his money, especially if retirement has already arrived, an income mandate makes the most sense. Under this mandate, the portfolio manager must prioritize current passive income from sources such as dividends, interest, and rents over long-term growth. This can mean selecting mature, slow-growing businesses with a long history of ever-increasing dividends, as well as corporate bonds, preferred stock, or real estate with good capitalization rates.
Speculation Investment Mandate
Whether it's for the thrill, a desire to get rich quickly, or the enjoyment of spotting opportunities to create outsized profits by being smarter than the system, a speculation mandate can encompass almost anything, from trading penny stocks to buying out-of-the-money short-term call options. Sometimes, an account with this mandate is "side money." The person who owns it already has their primary portfolio safely tucked away and compounding, so he keeps what he considers "play money" in a separate account.
Other Types of Mandates
An investment mandate can restrict a portfolio manager to specific asset classes, geographic areas, industries, sectors, valuation levels, market capitalizations, or anything else you can think of. For example, a global investment mandate means you should own stocks both in your home country and abroad, while an international investment mandate means restricting the portfolio to firms headquartered or doing business mostly outside of your home country.
A small-capitalization stock investment mandate means finding attractive firms that are below a certain market capitalization size. If your investment mandate specifies low turnover, that might mean restricting the percentage of the portfolio that can be sold in any given year to 3% or 5% — certainly less than 10%, the latter of which would imply an average holding period of at least a decade for each position.
The mandate you decide upon for your own accounts should be consistent with your current situation, goals, and Investment Policy Statement, or IPS.
Berkshire Hathaway. "Warren Buffet's Letter to Shareholders, 1993." Accessed Feb. 6, 2020.