Investment Management Agreements: Key Terms and Negotiation Guide for Hong Kong

An investment management agreement (IMA) is a foundational legal document that governs the relationship between an investor (the client) and an investment manager who manages assets on the client's behalf. Whether you are a family office appointing a third-party investment manager, an institutional investor engaging an asset management firm, or a fund sponsor retaining a sub-adviser, the IMA defines the boundaries of the manager's authority, the fee structure, the performance standards, and the rights and obligations of both parties. This guide explains the key provisions of an IMA and the most important negotiation points for clients in Hong Kong.

Legal and Regulatory Context

In Hong Kong, investment managers who manage a discretionary portfolio on behalf of clients are engaged in Type 9 regulated activity (Asset Management) under the Securities and Futures Ordinance (SFO). They must be licensed by the SFC to carry on this activity. The SFC's Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission sets minimum standards for IMAs, including requirements for:

• Clear documentation of investment objectives, restrictions, and guidelines in writing
• Fair and transparent fee disclosure
• Adequate risk disclosure
• Conflict of interest management
• Best execution obligations

Additionally, SFC-licensed investment managers must comply with the Fund Manager Code of Conduct for funds they manage. Clients should be aware that these regulatory requirements represent a minimum floor — negotiated IMA terms often provide additional protections.

Key Provisions of an Investment Management Agreement

1. Appointment and Scope of Authority

The IMA defines the scope of the manager's discretionary authority: what assets the manager can invest in, in what jurisdictions, using what instruments (equities, bonds, derivatives, alternatives), and to what extent. This section also specifies whether the manager has full discretion (authority to make all investment decisions without prior client approval) or limited discretion (requiring client sign-off for transactions above certain thresholds or in specific asset classes).

Institutional clients and family offices typically grant full discretion subject to the investment guidelines, since prior approval for each trade is impractical. The investment guidelines (often set out in a Schedule to the IMA) must be carefully drafted to reflect the client's risk appetite and constraints.

2. Investment Objectives and Guidelines

The investment guidelines are arguably the most important Schedule in the IMA. They set out:

• Investment objective: e.g., capital growth, income generation, capital preservation, or a blended objective
• Benchmark: the index or reference rate against which the manager's performance will be measured (e.g., MSCI Asia Pacific ex-Japan, HSCEI, or a bespoke blended benchmark)
• Asset class and instrument universe: what the manager can and cannot invest in (e.g., "listed equities and bonds only"; "no direct real estate"; "no investments in restricted countries")
• Concentration limits: maximum exposure to any single issuer, sector, country, or asset class as a percentage of the portfolio
• Leverage: whether the manager can borrow to leverage the portfolio, and if so, the maximum leverage ratio
• Currency policy: whether and to what extent the manager can hedge or take currency exposure
• ESG/SRI constraints: exclusions of certain industries (tobacco, weapons, fossil fuels) or requirements to integrate ESG factors into the investment process

The investment guidelines should be specific enough to constrain the manager's discretion in line with the client's risk appetite, but not so prescriptive as to make effective management impossible. Guidance from a legal adviser on achieving the right balance is valuable.

3. Management Fees

Management fees are typically structured as:

• Management fee: an annual percentage of assets under management (AUM), charged quarterly in arrears (typically 0.5%–1.5% for long-only equity or balanced mandates; lower for fixed income or passive strategies)
• Performance fee: a percentage of outperformance above a hurdle rate or benchmark (typically 10–20% of returns above the benchmark, subject to a high-water mark). Performance fees are more common in hedge fund and alternative mandates.
• Transaction costs: brokerage commissions and other transaction costs may be charged to the portfolio in addition to the management fee, or the manager may absorb some costs ("all-in" fee structures)

Key negotiation points on fees include:

• High-water mark: Ensure any performance fee is subject to a high-water mark, so that the manager only earns a performance fee on cumulative net gains (not on recovery of previous losses)
• Hurdle rate: Negotiate a meaningful hurdle rate (e.g., a risk-free rate or a benchmark return) above which performance fees are earned
• Fee calculation methodology: Clarify whether management fees are calculated on beginning or ending AUM, or average AUM over the period
• Fee offsets: If the manager invests in affiliated funds that charge their own management fees, ensure that the IMA management fee is reduced or offset to avoid double-charging

4. Liability and Indemnification

IMAs typically contain provisions limiting the manager's liability and providing indemnification in favour of the manager. Standard provisions include:

• Liability is excluded for losses arising from good-faith investment decisions made in accordance with the investment guidelines and the exercise of reasonable care and skill (i.e., no liability for ordinary underperformance)
• Liability is retained for losses arising from the manager's gross negligence, wilful misconduct, fraud, or breach of the IMA
• The client indemnifies the manager against claims by third parties arising from the client's instructions or the client's own actions

Client negotiation strategy: Avoid accepting exclusions of liability for negligence (as distinct from gross negligence). Clients should insist that the manager retains liability for at least ordinary negligence in the management of the portfolio. Also negotiate for mandatory professional indemnity insurance coverage by the manager.

5. Conflicts of Interest

The SFC's Code of Conduct requires investment managers to disclose and manage conflicts of interest. The IMA should address:

• Side-by-side management: How the manager allocates investment opportunities among multiple clients managing similar strategies (allocation policy)
• Affiliated transactions: Whether the manager can invest the portfolio in securities issued by affiliated entities, invest through affiliated brokers, or invest in affiliated funds, and what safeguards apply
• Soft commissions: Whether and to what extent the manager can direct brokerage to brokers in exchange for research and execution services (soft dollar arrangements). The SFC has strict rules on acceptable soft commission practices.
• Cross trades: Whether the manager can trade between client accounts managed by the manager at a price other than market (cross trades are tightly regulated and generally require prior disclosure and consent)

6. Custody

The IMA should specify who holds the portfolio assets in custody. Typically, assets are held by a third-party custodian (a bank or prime broker), not by the investment manager itself. Key points:

• The IMA should confirm that the manager has no authority to instruct the custodian to transfer assets except for the purpose of executing investment transactions
• The client should appoint a custodian independently of the manager to ensure segregation of management and custody functions
• The IMA should address what happens if the custodian becomes insolvent

7. Reporting

Investors should negotiate for regular, detailed reporting obligations, including:

• Portfolio valuation: Monthly (or more frequent) valuation statements showing portfolio holdings, values, and cash positions
• Performance attribution: Quarterly performance reports attributing portfolio returns to specific positions and asset classes, compared to the benchmark
• Transaction reporting: Periodic statements of all transactions executed in the period
• Risk reporting: Reports on portfolio risk metrics (volatility, Value-at-Risk, tracking error, duration for fixed income)
• Annual review meetings: The right to meet with the portfolio manager (not just a client relationship team) at least annually to review performance and strategy

8. Termination

IMAs should give both parties clear termination rights:

• Termination for convenience: Either party should be able to terminate the IMA for any reason upon agreed notice (typically 30–90 days). Clients should resist accepting very long notice periods that prevent them from switching managers.
• Termination for cause: Immediate termination should be available for material breach, insolvency, loss of SFC licence, change of control of the manager, or departure of key investment personnel
• Post-termination obligations: The IMA should specify how the portfolio is transitioned on termination (e.g., liquidation vs. transfer in specie), who bears liquidation costs, and how accrued fees and performance fees are settled
• Key person event: If the mandate relies on specific named individuals, negotiate for a right to terminate (or at minimum a fee holiday) if those key persons depart from the manager

9. Governing Law and Dispute Resolution

Hong Kong IMAs typically provide for Hong Kong law as the governing law and for disputes to be resolved by:

• Hong Kong court litigation; or
• Arbitration (HKIAC arbitration is common for higher-value mandates, given confidentiality and enforceability advantages)

Special Considerations for Family Offices

Family offices appointing external investment managers should pay particular attention to:

• Co-investment rights: Negotiate the right to co-invest alongside the manager's other clients in deals not available to the general mandate
• Transparency of cost: Full transparency on all fees, costs, and commissions (including transaction costs, custodian fees, and any soft dollar arrangements)
• Direct communication access: The right to speak directly with the portfolio manager, not just with relationship management or client service staff
• Reporting customisation: Customised reporting to support the family office's consolidated reporting and tax compliance needs
• Sub-adviser disclosures: If the manager delegates to sub-advisers, ensure full disclosure and the right to approve sub-adviser appointments

Conclusion

An investment management agreement is a complex legal document with significant financial implications. While institutional investors and large family offices often have experienced in-house legal teams to review and negotiate IMAs, smaller investors frequently accept the manager's standard form without appreciating the protections they may be waiving. Seeking independent legal advice before entering into an IMA is a sound investment.

Alan Wong LLP advises family offices, institutional investors, and investment managers on the drafting, review, and negotiation of investment management agreements in Hong Kong. Contact us to discuss your investment management requirements.