A Transitive Property of Fiduciary Duties?

A Transitive Property of Fiduciary Duties?

If A = B and B = C, then A = C. This is the “transitive property of equality” that we learned in our remedial algebra classes so long ago.

Is there a transitive property of fiduciary duties?  We know that the trustee owes duties of care to the trust beneficiaries. We also know that an investment advisor registered under the Investment Advisers Act of 1940 is a fiduciary to their clients, including those who are trustees.  Can it be said that if a trustee hires a Registered Investment Advisor to manage the trust capital, the trustee has fulfilled their fiduciary duties to the beneficiaries? No! Because there is no transitive property of fiduciary duties.

The duties that an RIA owes to the Trustee are different duties than a trustee owes to the beneficiaries they service. And yet trustees and investment advisors confuse these facts all the time. Trustees wrongly think, “I’ve hired a fiduciary investment advisor, which means my job is done.” Nope. Or the RIA wrongly thinks, “I understand Modern Portfolio Theory and the Prudent Investor Act. There is no reason for the trustee to review my activities because I am already in compliance.”  Nope.

For the most part the trustee is prohibited from delegating key decision making authority to any third party. Only the trustee has the authority to set the return objectives or risk expectations for the trust capital. Only the trustee has the authority to determine what a reasonable distribution rate is. Only the trustee is responsible for testing whether the fee charged by the RIA is fair or if the investment advisor’s portfolio is diversified. Only the trustee has the responsibility to independently monitor the activities of the investment advisor even if the investment advisor is a fiduciary to the trustee.

The trustee does NOT get a hall pass if they hire an investment advisor who is a fiduciary and registered under the Investment Advisers Act of 1940. The only duty that the trustee is absolved from doing is the day-to-day management of the trust capital. But all other duties, including prudently delegating to and monitoring the investment advisor, are responsibilities that the trustee must still fulfill.

There is no transitive property of fiduciary duties. To learn more about how to develop and maintain an investment governance process, click here:  

Investment Governance Overview

Anodos acts like a Chief Compliance Officer for trustees of all types: individual trustees, ERISA trustees and foundation/endowment board members. We develop and maintain for our clients a fiduciary governance process that fulfills their oversight responsibilities. Because we do not sell insurance, manage money, or receive referral fees from any sources our governance work is truly unconflicted.

Please email or call me if you would like more information about how we do this work and how it may apply to you or your clients’ needs.

Onward,

Josh Yager, Esq., CFP®, ChFC®, CLU®
115 E. Micheltorena, Suite 100
Santa Barbara, CA 93101
jyager@anodosadvisors.com
805-899-1245

A Trustee’s Duty to Independently Monitor Investment Advisors

A Trustee’s Duty to Independently Monitor Investment Advisors

“A trustee shall exercise reasonable care, skill and caution by periodically reviewing the agent’s actions in order to monitor the agent’s performance and compliance with the terms of the delegation” – Uniform Prudent Investor Act §9(a)(3).

Many trustees implicitly trust the investment advisor to whom investment duties have been delegated. They trust that the advisor’s strategy is reasonable. They trust that the return the advisor produced was reasonable given the level of risk that was taken. They trust that the benchmark the advisor is comparing himself against is fairly established. They trust that the advisor’s fees are fair. They trust that the advisor’s representation of being “above average” is supported by facts.

This kind of trust may be good enough for some, but for trustees it is not. Few trustees have any evidence – other than what their investment advisor says – that the trust assets are reasonably invested. Trustees are obligated by the Prudent Investment Act to make their investment decisions based on something more than trust. They are obligated to find the facts and record the basis for the confidence they put in the investment advisors they have decided to use.

However, conducting this level of review requires an insider’s knowledge of the investment industry. It requires experience to ferret out the facts from the promotional claims. It requires a disciplined investigation that few trustees are equipped to conduct. In short, it is hard to establish the facts upon which the fiduciary’s trust is placed. We know that a trustee’s job is hard, but though it is hard it does not absolve them of responsibility.

Anodos acts like a Chief Compliance Officer for trustees of all types: individual trustees, ERISA trustees and foundation/endowment board members. We develop and maintain for our clients a fiduciary governance process that fulfills their oversight responsibilities. Because we do not sell insurance, manage money, or receive referral fees from any sources, our governance work is truly unconflicted.

Please email or call me if you would like more information about how we do this work and how it may apply to you or your clients’ needs.

Josh Yager, Esq., CFP®, ChFC®, CLU®
josh@anodosadvisors.com
805-899-1245

Investment Governance Overview: Is my investment advisor doing a good job?

Investment Governance Overview: 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 this question is so hard to answer is that the capital owner (the “employer”) has failed to clearly define and measure the job for which the advisor (the “employee”) has been hired. Too often, defining the investment objectives and key performance indicators is left to the advisor with predictable results. It is for the capital owner to define the job that the advisor has been hired to accomplish. Absent clear instructions from the employer, it is impossible to evaluate the employee’s effectiveness.

The Solution

A prudent capital owner will: (1) identify the financial objectives they are seeking to accomplish; (2) define investment policies that inform the 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

Following are examples of the types of objectives and expectations that define the terms of employment.  (The capital owner’s particular investment objectives, expectations, policies and procedures will likely differ from this illustration.)

  • Long-Term Targeted Return: Inflation+3.0%, which can be alternatively stated as a nominal 6.0% return, in a normalized 3% 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: Expected drop of <20%>, or $1,000,000 of the current $5,000,000 portfolio value, during a typical bear market.

Investment Policies & Procedures

Not only will the capital owner define the financial objectives, but also the parameters that the advisor must abide by. Following are examples of several key investment policies and procedures that a capital owner should identify. (Again, the capital owner’s particular 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, 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.
  • Liquidity Requirements: At least 90% of the portfolio must be invested in securities that can be liquidated within 2 business days of the capital owner’s instructions (SEC T+2 settlement).
  • Alternative Investments: In those instances when the advisor recommends that an “Alternative” investment be included in the portfolio, the advisor shall provide a series of disclosures in writing.
  • Diversification: On an annual basis the advisor will provide a report that identifies the largest three (1) non-pooled holdings; (2) industry sectors; and (3) asset classes held in the portfolio (both by $ and %).
  • Management Cost: On an annual basis the fee charged by the advisor shall be compared to the results of an independent fee study comparing portfolios of comparable size, complexity and product mix.

The Employee Review

After the capital owner’s financial objectives and investment principles are defined, the advisor will: (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 believe will optimize their portfolio design; and (3) make tactical shifts in the portfolio based on their assessment of prevailing risks or opportunities.   

The advisor’s activities are compared against the investment objectives, policies, and key performance indicators that are the foundation of the employment relationship.  It is through this governance process that the client will be able to know if the advisor they have selected is doing the job they were hired to do.  

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 provide this level of detail. Further, they, like all employees, are not in the position to independently evaluate 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.

 

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.

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.

Bank v RIA as Investment Advisor:  A Cost-Benefit Analysis

Bank v RIA as Investment Advisor: A Cost-Benefit Analysis

Many investors ask, “Is it better to have a big bank (Goldman Sachs, for example) as my investment advisor or a Registered Investment Advisor (Bel Air, for example) to manage my money?” Following is a summary of the costs and benefits of each. The best investment platform should be determined by each investor’s unique preferences and principles. In short, reasonable minds can differ.

Bank Advantages Over RIA

  • Too big to fail.  Very rarely will a bank go out of business, but RIAs will with greater frequency have ownership transitions through acquisition, merger, or closure.
  • A flexible platform. Each advisor has broad latitude to meet their client’s needs in a way that they believe is suitable. Few banks dictate an institutionalized solution that must be accepted. Depending on the bank, the platform varies from flexible to very flexible in how the advisor may decide to implement the client’s portfolio.
  • “Deal flow” Banks have a distinct “investment banking” department that provides bank investment clients early access to interesting private equity deals and new issue public offerings.
  • Greater autonomy and flexibility in fee negotiation. Each advisor is a business unit that can, within company guidelines, establish the client-level fee for the particular services or products being provided to that client.  RIAs are much less flexible in their fee negotiations.
  • Integrated banking functions with investment management solutions. Cash flow management, short-term credit facilities, long-term credit facilities (mortgages), personal banking, insurance, et cetera can be provided under one roof.

 

RIA Advantages Over Bank

  • Fiduciary Standard applies to all accounts. An RIA is not allowed to receive income from any other source than the client.  It is difficult, even impossible, for a bank to say that there are no potential conflicts of interest in their management implementation.
  • Institutionalized investment process. Investment decisions are typically made by an investment committee that has a definable and defensible investment strategy and process that is institutionalized and does not vary from client to client. Few banks have this rigid, institutionalized investment process. Most banks have a collaborative “so what do you think about this strategy” approach which makes accountability and measurement of future results difficult to directly attribute to the advisor. This blurring of lines of responsibility is less likely to happen with an RIA. If you like what they do, you buy their strategy and get their solution.
  • Fees tend to be easy to calculate.  Fees charged on “assets under management” utilize an agreed upon fee schedule. Most banks have a variety of fee arrangements which differ between clients based on the various strategies that the investment advisor recommends.
  • Service continuity. You deal with employees at an RIA who may come and go, but if they leave the firm, there is service and strategy continuity. There is little risk of advisors moving from firm to firm every few years and asking clients to follow them because the “new firm offers more flexibility.”