Legal Definitions - investment discretion

Investment discretion refers to the authority a person or entity has to make independent decisions about buying or selling investments for a client's or an account'sportfolio, without needing to obtain specific approval for each individual transaction. This means they have the power to choose which specific assets (such as stocks, bonds, or real estate) to acquire or sell, when to do so, and in what quantities, based on the client's overall objectives and risk tolerance. It can also encompass situations where a person significantly influences such investment decisions to a degree that regulatory bodies consider it a form of control, subjecting them to specific rules and oversight.

Here are a few examples to illustrate this concept:

• Example 1: A Financial Advisor Managing a Retirement Account

  A client hires a financial advisor to manage their Individual Retirement Account (IRA). The client provides the advisor with their financial goals, risk tolerance, and time horizon. Based on this information, the advisor is authorized to make all the day-to-day investment decisions—such as buying shares of a particular mutual fund, selling a specific stock, or rebalancing the portfolio—without needing to contact the client for approval before each trade. The advisor regularly reports on the account's performance but executes transactions independently.

  This illustrates investment discretion because the financial advisor has the direct authority to determine what investments are purchased and sold for the client's account, making decisions without requiring prior client consent for each transaction.

• Example 2: A Portfolio Manager for a Hedge Fund

  A portfolio manager for a large hedge fund is tasked with investing the fund's capital according to its stated strategy (e.g., long/short equity). The manager identifies an undervalued company and decides to purchase a significant block of its shares for the fund. Simultaneously, they decide to sell off a position in another company they believe is overvalued. These decisions are made by the portfolio manager based on their analysis and the fund's strategy, without needing to consult the individual investors who have contributed capital to the hedge fund.

  Here, the portfolio manager exercises investment discretion by independently deciding which securities to buy and sell for the collective fund's account, directly controlling the allocation and movement of assets.

• Example 3: A Trustee Managing a Charitable Trust

  A wealthy individual establishes a charitable trust, naming a professional trustee to manage its assets. The trust document grants the trustee broad powers to invest the trust's funds to generate income for various charitable causes, while also preserving the principal. The trustee decides to diversify the trust's portfolio by investing in a mix of government bonds, corporate stocks, and a commercial real estate fund. They make these investment choices based on market conditions and the trust's objectives, without needing to seek approval from the trust's beneficiaries or the original donor for each specific investment.

  This demonstrates investment discretion because the trustee has the power to decide what will be purchased or sold for the trust's account, even though their ultimate responsibility is to manage the assets for the benefit of the charitable causes.