By FADEL N. LAWANDY / CHAPMAN UNIVERSITY FACULTY
It is often argued that having a great money manager is as critical as having a great family doctor. While the family doctor works to insures one’s physical health, the money manager works to insure one’s financial health. Yet there are three factors that the average consumer gives very little attention to when selecting a money manager.
Investment philosophy and investment policy statement
The preference is for the money manager to have a clear investment philosophy and to utilize an investment policy statement to define the framework of the relationship with each client.
It is of great importance to have a good understanding of what the money manager’s investment philosophy is. The first rule of investing is to buy low and sell high. The question to the money manager should be, “what is the process by which to accomplish that mission?”
A successful money manager must have a clear and well-thought-out process to managing clients’ assets. More importantly, he or she should be able to clearly articulate the process to the clients. This allows money managers to be deliberate in their investment decisions and successful on the long run in managing clients’ assets.
The investment policy statement (IPS) is an extension of the investment philosophy. The IPS tailors the investment philosophy of the money manager to the needs and goals of the client. Money managers that utilize the IPS as part of their everyday practice demonstrate a higher level of skills in serving their clients.
Fiduciary vs. suitability standards
Money managers that provide advice and recommendations to their clients have a fiduciary responsibility to their clients. Fiduciary responsibility dictates that the professional must act in the best interest of the client, disclose any and all conflicts of interest, and must put the interests of the client before their own.
Some money managers are licensed as brokers, not as investment advisors. Their obligation is limited to a suitability standard. The standard dictates that the recommendations of the money manager must be suitable for the client, notwithstanding conflict of interest or the investment selection being the best option. For example, a broker representing a mutual fund company may recommend a suitable mutual fund offered by his firm. While the money manager had met his suitability standard in recommending the mutual fund, the recommendation may not be the best performing amongst its peers or the lowest in fees.
Clearly a money manager who is held to a higher standard (fiduciary responsibility) is the best option when possible. To verify what standards the money manager follows, it is always advisable to ask for a copy of the money manager’s or firm’s code of ethics. The key here is to identify whether the money manager is required and expected to act in a fiduciary capacity. It is also good practice to review the money manager’s background and licensing on regulatory websites (example: FINRA.org and SEC.gov). The websites offer a great deal of information on whether the money manager is registered as a broker or investment advisor, licensing and qualifications, work history, outside activities, any investigation or disciplinary action by regulatory bodies, any history of clients’ complaints, and financial disclosures.
CFA (Charter Financial Analyst) and CFP (Certified Financial Planner) designations are both examples of third-party designations. To have the rights and privileges of using the CFA or CFP designation, investment professionals must meet professional work experience requirements, pass comprehensive examinations and abide by a strict code of conduct. Consumers should preference selecting professionals with credible third-party designations, since the regulating organizations go to great efforts to maintain the integrity and high standards associated with the designations they offer.
This does not rule out firm (internal) designations, which require even stricter scrutiny. The most common internal designation is the vice president designation. Firms have different standards for internal designations. It is important to inquire what accomplishment(s) were achieved for such recognition. Is it the number of years with the firm or in the profession? Is it advanced certification and degrees in the area of investments? Is it the amount of assets or revenue brought into the firm? Or is it a combination of two or more of these accomplishments? The question is this: is the financial advisor being recognized for his/her skills as a money manager or because he/she is a great salesperson? Similar processes can be applied to other internal designations. The preference here is for the money manager to have achieved the designation for activities that benefit the client.
Fadel Lawandy is an assistant professor of finance and real estate at Chapman University and currently serves as interim director of Chapman’s C. Larry Hoag Center for Real Estate and Finance.