Is my investment advisor doing a good job?

Is my investment advisor doing a good job?

The Problem

It’s difficult to answer the question, “Is my investment advisor doing a good job?”  Predictably, all investment advisors report that they are “doing great” and are “above average.”  They all provide compelling charts, graphs and benchmarks to confirm their conclusions.  The reason that this question is so hard to answer is that the capital owners (the “employers”) have failed to clearly define and measure the job for which the investment advisor (the “employee”) has been hired. Too often, defining the investment objectives and key performance indicators is left to the investment advisor with predictable results. It is for the capital owner (employer) to define the job that the investment advisor (employee) has been hired to accomplish. Absent clear instructions from the employer, it is impossible to evaluate the employee’s investment acumen.  

The Solution

A prudent capital owner will: (1) identify the financial objectives they are seeking to accomplish; (2) define investment policies that inform the investment advisor’s activities; and (3) establish procedures to test that the policies are being complied with. This three-step process is the framework for effective investment governance for both large and small portfolios. The capital owner’s question “Is my investment adviser doing a good job?” cannot be answered unless these investment policies and procedures have been established in writing.

The Job Description

The investment advisor’s job is to: (1) design a portfolio that is expected to accomplish the client’s financial objectives with low relative risk; (2) select the products, securities, or sub-managers that they feel will best optimize the portfolio they have designed; and (3) make tactical shifts with either the asset allocation or security holdings based on their assessment of prevailing risks or price deviations from intrinsic value. That is the job for which the investment advisor is being hired.

The Employee Review

Once the job has been defined by the employer (capital owner), the outcome that the employee (investment advisor) is being hired to manage toward must be defined. Following is an example of key objectives and expectations that are the foundation of the investment advisor’s employment.  (The capital owner’s particular investment objectives, expectations, policies and procedures will likely differ from the sample answers provided in this illustration.)

  • Long-Term Targeted Return: Inflation + 3%, which can be alternatively stated as 6%, in a normalized inflation environment.
  • Investment Time Horizon: The remaining life expectancy for the capital owner is projected to be 32 years per the IRS actuarial tables.  
  • Projected Distribution: $200,000 per year (4% of the $5,000,000 portfolio value).
  • Risk Expectations: 10% Standard Deviation with a normal range of annual returns between 16% on the high side and <4%> on the low side.
  • Bear Market Expectations: Temporary downside deviation of <20%> or $1,000,000 of the current $5,000,000 portfolio value.

Investment Policies & Procedures

Not only will the employer (capital owner) define the performance objectives as noted above, but they will also define the parameters that the employee (investment advisor) is to adopt while doing their job. Following is an example of the key Investment Policies and Procedures that a capital owner should define. (Again, the capital owner’s particular investment objectives, expectations, policies and procedures will likely differ from the examples provided in this illustration.)

Performance Reporting: Performance reporting shall be provided at least quarterly and will be calculated according to the CFA Institute’s performance standards (time weighted rate of return net of fees).

Benchmarking: The portfolio will be compared against a series of blended benchmarks that reasonably approximate the risk and return characteristics of the portfolio. These benchmarks will include, at a minimum: (1) an advisor-suggested benchmark; (2) a strategic benchmark*; and (3) a peer group benchmark.

Liquidity Requirements: At least 90% of the portfolio shall be invested in securities that can be liquidated within 2 business days of the capital owner’s instructions (SEC T+2 settlement). The balance of the portfolio (10%) may be invested in investment products or strategies that do not provide 2-day liquidity.

Alternative Investments: So called “Alternative” investments may be used in the portfolio so long as: (1) the liquidity requirement above is met; and (2) appropriate disclosures about these assets are made by the investment advisor.  In those instances when the advisor recommends that an “Alternative” investment be included in the portfolio, the advisor shall provide the following disclosures in writing:

  • A description of the investment;
  • The expected term of the investment;
  • The level of capital committed to the investment (both in $ and %);
  • A summary of the fees associated with the investment;
  • A disclosure of any potential conflicts of interest that may exist;
  • The anticipated risk (standard deviation) of the investment as a ratio to that of the S&P 500;
  • The anticipated return of the investment as a ratio to that of the S&P 500; and
  • The expected correlation to the S&P 500.

Diversification: On an annual basis the investment advisor will provide a report that identifies the largest five: (1) non-pooled holdings; (2) industry sectors; and (3) asset classes held in the portfolio (both by $ and %).  If there is concentration greater than what a prudent investor would accept, a memo will be written memorializing the rationale for the concentration.

Investment Cost: On an annual basis the fee charged by the investment advisor shall be compared to the results from an independent fee study comparing portfolios of comparable size, complexity and product mix. Additionally, this report shall include the weighted cost of the underlying pooled investment products or sub-advisors as compared to the average expense ratio of the no-load mutual fund universe for the same asset classes.

Concluding Remarks

Without a job description an employee’s performance cannot be assessed. Without written investment governance policies and procedures an investment advisor’s efficacy cannot be evaluated.

For the most part, the investment industrial complex is at best unable, or at worst unwilling, to provide this level of documentation or accountability to their investment process. Their internal compliance departments simply will not allow them to do provide this level of detail. Further, they, like all employees, are not in the position to independently assess their own activities.

Anodos helps capital owners develop and manage an investment governance process. For many of our clients this oversight responsibility is not merely a subject of curiosity, but a duty they are obligated by statute to fulfill on behalf of the beneficiaries and organizations they serve.  What makes Anodos unique is this is all we do. We don’t manage money, sell insurance, or accept referral fees. We don’t have a horse in the race.

 

*The Strategic Benchmark is made up of the Russell 3000, MSCI ACWI ex US and Barclays Aggregate Bond indexes in proportion to the portfolio’s beginning allocation.

Is your client’s investment advisor better than average?

Vanguard vs. Client: The Vanguard LifeStrategy Moderate Growth Fund (VSMGX) is (1) well diversified (60% global stocks and 40% bonds), (2) inexpensive (0.15% per year), (3) has a long and successful 20-year track record, and (4) is really big ($15b). How does your client’s moderately allocated portfolio with a similar risk and return profile compare to this off-the-shelf retail product? (If your client is more conservative than the 60% stock and 40% bond Vanguard fund, you can use the more conservative Vanguard LifeStrategy Conservative Growth Fund (VSCGX), which is allocated 40% stock and 60% bonds.)

But is comparing an off-the-shelf retail mutual fund that is made for “little investors” an appropriate comparison to the sophisticated, big firm, best thinking solution your client is currently using? Like all benchmarks, this comparison is  probably not a perfect fit, but it is in the right zip code.

A prudent business manager will use a series of reasonable benchmarks, including a Peer Group Benchmark, to test whether the claims made by their clients’ investment managers are supported by objective measurement and not subjective platitudes.

At Anodos, we help fiduciaries answer the question, “Is my investment advisor doing a good job?” Many of our clients are individual trustees, business managers, ERISA trustees and endowment board members who are obligated to independently monitor the activities of the agents to whom investment duties have been delegated. What makes us unique is this is all we do. We don’t manage money, sell insurance, or accept referral fees. We don’t have a horse in the race.

The Emperor Has No Clothes

The investment industrial complex does not want you to know how to evaluate its members. If it did you would have easy access to the following data:

  1. Each investment advisor would establish a target rate of return that could be measured against in future years.
  2. Each investment advisor’s portfolio would be compared to several reasonable benchmarks to test if the risk/return relationship that the investor experienced was in the right zip code.
  3. Each investment advisor would provide their clients a  clear, written fee agreement.
  4. Each investment advisor would disclose in writing all potential conflicts of interest.
  5. Each investment advisor would provide a performance report that is understandable and supports the client in knowing how the advisor was doing compared to agreed upon key performance indicators.

But you don’t have easy access to this data. The investment industrial complex does not require its members to provide this level of disclosure to its clients.  So it’s on you to figure out how to monitor your investment advisor because the industry has no incentive to teach you how.

Following is a link to a short video on how to test if your emperor is wearing clothes:

How to test if your emperor is wearing clothes

Onward,

Josh Yager. Esq. | Portfolio PI

At Anodos, we help fiduciaries answer the question, “Is my investment advisor doing a good job?” Many of our clients are individual trustees, business managers, ERISA trustees and endowment board members who are obligated to independently monitor the activities of the agents to whom investment duties have been delegated. What makes us unique is this is all we do. We don’t manage money, sell insurance, or accept referral fees. We don’t have a horse in the race.

Questions to Ask an Investment Advisor Before They are Hired aka ”The Interview”

Questions to Ask an Investment Advisor Before They are Hired aka ”The Interview”

At times it becomes necessary to end a relationship with one investment manager and begin a relationship with a new firm. When such a change has been decided upon, it is best practice to not rush to the next investment manager that promises good returns, low fees, and excellent client service. Instead, a thoughtful investor will take the time to solicit proposals from several investment managers who have a good reputation and standing within the investment community.

 

This “manager search” will include the following steps:
  • Identify candidate managers.
  • Contact candidate managers to determine if they are willing to participate in a formal Request for Proposal process.
  • Deliver a data collection packet to the candidate managers (link to sample).
  • Collect candidates’ investment responses/proposals.
  • Evaluate similarities and differences between the candidates’ responses.
  • Evaluate whether the candidates’ responses are in harmony with the client’s own investment objectives and principles. (In most cases clients have not taken the time to define these unique financial objectives and investment principles. It is really important that these be defined because they will serve as the foundation of the engagement with the new investment manager.)
  • Deliver to the selected candidate(s) the client’s Investment Objectives, Principles and Procedures document, and coordinate relationship and asset transition.

Download Sample RFP Questions

At Anodos, we help our clients answer the question, “Is my investment advisor doing a good job?” Many of our clients are individual trustees, business managers, ERISA trustees and endowment board members who are obligated to independently monitor the activities of the agents to whom investment duties have been delegated. What makes us unique is this is all we do. We don’t manage money, sell insurance, or accept referral fees. We don’t have a horse in the race.

Will ERISA Trustees ever learn? or “I guess they aren’t that smart at Princeton”

Will ERISA Trustees ever learn? or “I guess they aren’t that smart at Princeton”

The Duty: An ERISA trustee is obligated to know who is being paid what by whom and whether the fees being paid are fair and reasonable. This duty is implicit in the trustee’s duty of prudence under C.F.R. §404a-1 and is specifically required by the U.S.C. §1104(a)(1)(A)(ii).

The Breach: The ERISA plan trustees at Boeing and Lockheed Martin and Fidelity and Aon Hewitt and Verizon and Oracle and Intel and Xerox and many, many other Fortune 500 companies have paid out billions of dollars in settlements or damages arising from ERISA class action lawsuits. The trustees of all these mega plans fell asleep at the switch and approved expensive retail fee agreements when wholesale fees were available. And recently a class action claim was filed against Princeton University making the same claim–excessive fees and below average performance.

The Complaint: The complaints always say the same thing because they are filed by the same class action law firm that specializes in this work:  “[Plan Sponsor] selected and retained investment options for the plans that historically and consistently underperformed their benchmarks and charged excessive investment management fees, as well as share classes that were more expensive than other share classes readily available to qualified retirement plans that provided plan investors with the identical investment at a lower cost.”

Wholesale v. Retail: Plan trustees, I’ll break it down for you; PAY WHOLESALE, NOT RETAIL! If you are buying a fleet of 1,000 cars  from GM you’re not going to pay retail. If you are buying hotdogs for Dodger Stadium you’re not going to pay retail. If you are buying laptop computers for all the students in a school district you’re not going to pay retail. So why do ERISA trustees keep agreeing to pay retail prices to the investment industrial complex?

Trust but Verify: Do ERISA trustees really think the service providers they are using are going to say, “Hey, ERISA trustee, I think the funds we made available to your participants have above average fees and below average performance!” It’s never going to happen because the vendors (service providers) do not owe any fiduciary duties to the plan sponsors who use them.  It is the plan trustees’ job to do this performance and fee investigation. If the investment committee doesn’t have time to do this work or doesn’t have the experience to do it, they should hire a fiduciary governance consultant to do this work. Obviously the current investment consultant is disqualified from reviewing their own work.  A performance and fee investigation is fundamental to the prudent administration of the plan.

 

At Anodos, we help our clients answer the question, “Is my investment manager doing a good job?” Many of our clients are individual trustees, business managers, ERISA trustees and endowment board members who are obligated to independently monitor the activities of the agents to whom investment duties have been delegated. What makes us unique is this is all we do. We don’t manage money, sell insurance, or accept referral fees. We don’t have a horse in the race.