Simply defined, in this context a fiduciary is any individual who manages assets on behalf of a client, beneficiary or retirement plan and stands in a special relationship of trust, confidence, and/or legal responsibility. By law, fiduciaries are required to consistently and continually act in the best interests of the clients they serve. Examples may include Investment Committee members, trust officers, retirement plan sponsors, and money managers. Fiduciaries may not be judged solely on the outcomes of their decisions, but on their ability to fulfill their primary responsibility: creating and maintaining a well-defined, prudent process by which investment decisions can be made.
Creation
and management of a prudent investment process begins with structuring the Investment
Committee itself. First, the Investment Committee
must clearly define its role in the decision making process. Will the Committee be responsible for making
fiduciary decisions themselves, or will they simply research, discuss and
provide recommendations to another group or Executive Committee? Many times, Investment Committee members are responsible
for both research and making final fiduciary decisions.
Once the role of the Committee has been established, responsibilities and expectations can be identified for individual Committee members. For the Committee to be effective, members must be active and prepared. Processes should be put in place to ensure pertinent and relevant materials are distributed to all members. Subject matter experts, including a third-party investment consultant, should be engaged to assist the Committee in continually fulfilling their fiduciary responsibilities.
In
addition to clearly defining the roles and responsibilities of the Committee, members
should maintain an in-depth, unified understanding of the purpose and goal of a
given portfolio. This includes any
applicable standards, laws and provisions.
Typically, this is achieved through the creation of a formal, written
Investment Policy Statement (IPS). The
IPS serves as an objective framework outlining strategies that the Committee
must follow when making investment decisions.
The IPS should identify a clear investment strategy based on a set of reasonable assumptions regarding overall risk tolerance and expected portfolio return. After the portfolio’s objective has been established, Committee members can begin building a set of guidelines to evaluate the Committee’s progress in meeting the goals. Guidelines should include criteria for selection, evaluation and termination of investments and/or investment managers that are well defined but not so restrictive as to automate the decision-making process. An explicit strategy for risk control including asset allocation limitations and rebalancing procedures should be discussed.
The
process of evaluating investments and/or investment managers should be
straightforward and multi-dimensional.
Although performance is important, it cannot be the sole criteria by
which investments are judged. For
example, a manager’s depth of knowledge, approach, investment philosophy,
strategy, due diligence process, volatility, transparency, liquidity and
overall business health must all be taken into consideration. In today’s environment of lower investment
returns, Committee members should be fee-conscious as well.
The IPS must also establish procedures for continuous monitoring and review of underlying investments. The IPS should identify applicable benchmarks and peer groups to which investments can be compared. Investments should be reevaluated regularly based on performance and other relevant criteria. A well-defined process for replacing underperforming investments and/or managers should also be included. It is important to remember, however, that markets are cyclical, resulting in periods when an investment or group of investments may underperform. Committee members have the responsibility to maintain an in-depth understanding of each investment, and the factors contributing to its performance. Committee members should focus on making sound decisions based on an investment’s long-term viability and not short-term market fluctuations.
Once
the IPS has been established, Investment Committee members can turn their focus
to monitoring the portfolio on an ongoing basis. Agenda-driven meetings should be held regularly
to review manager performance, evaluate the portfolio’s ability to meet its
stated objectives and address any necessary changes. Quarterly reviews tend to work well; however,
meetings can be scheduled as frequently as necessary to address specific
issues. Providing a sufficiently
detailed agenda and supporting materials to Committee members in advance of any
meeting is critical to the Committee’s overall effectiveness and ability to
meet their fiduciary responsibility.
Active meeting participation by well-informed Committee members tends to
foster a confluence of different ideas and viewpoints, ultimately leading to more
productive meetings.
Since Investment Committees and their members function as fiduciaries and are held to a standard of prudent experts, it is generally a good idea for the Committee to keep a record of all decisions and actions. Detailed meeting minutes outlining topics discussed and decisions made can be used to demonstrate the Investment Committee’s continued dedication to managing the portfolio consistent with the IPS and all stated portfolio goals. While the depth to which meeting minutes are kept is up to the discretion of the Investment Committee, it is generally best to, at minimum, clearly document any decisions the Committee reaches and the rationale applied during the decision making process.
As time goes on, market conditions, participant needs and portfolio goals may change. It is the responsibility of the Investment Committee and its members to continually revisit and revise policies and procedures, maintaining a consistent process that is both adaptable to specific situations and adjustable to meet the demands of new and different situations. Changes, however, should not be made lightly and only when necessary.
Serving on an Investment Committee can be challenging. Committee members accept a great deal of responsibility and are often faced with many differing opinions on how to fulfill stated portfolio goals. Decisions often involve trade-offs between current needs and a commitment to long-term objectives. The most effective Investment Committees are able to fulfill their fiduciary duty by creating and maintaining prudent processes consistent with the IPS, by which any investment decision can be made with clients’ best interest in mind.
Ira Rapaport, MST, CPA/PFS, CIMA®, CFP®, AIF®
CEO/Managing Member
NEW ENGLAND PRIVATE WEALTH ADVISORS, LLC