Do you have a sound process for selecting your investments, as well as the service providers that will assist with implementing the investment process? The Center for Fiduciary Studies made its business defining a prudent investment process. They analyzed the rules of several legal Acts that govern investments, including the Employee Retirement Income Security Act. They found that seven standards of care are common to all of the acts, called Global Fiduciary Precepts.
Global Fiduciary Precepts putting structure to an investment process
- Know standards, laws, and trust provisions
- Diversify assets to specific risk/return profile of client
- Prepare investment policy statement
- Use “prudent experts” and document due diligence
- Control and account for investment expenses
- Monitor the activities of “prudent experts”
- Avoid conflicts of interest and prohibited transactions
I believe the first standard to understand is your responsibility and liability, if any.
Fiduciary roles in managing an investment process
Generally speaking, Investment Fiduciaries can be divided into three groups based on the primary role each serves in managing the money of others.
- Investment Stewards are fiduciaries who manage the overall investment process. Examples members of investment committees of retirement plans, foundations, and endowments.
- Investment Advisors manage the investment process. The primary difference is that Advisors are regulated investment professionals who provide comprehensive and continuous advice.
- Investment Managers are responsible for making (as opposed to managing) investment decisions. They buy and sell individual securities for an investment portfolio. Examples include money managers who are responsible for separate accounts, mutual funds, commingled trusts, and unit trusts.
The responsibility and liability of a prudent investment process
A fiduciary, such as an Investment Steward or an Investment Advisor, can never abdicate their fiduciary responsibility—it can be shared with other “co-fiduciaries,” but never given away.
However, a fiduciary can reduce, if not nearly eliminate, liability by following prudent practices, such as the practices covered in the AIF program. The best way to mitigate risk is to consistently apply sound investment processes, in other words, exhibit fiduciary excellence.
By establishing and following a well-defined investment process can avoid most allegations of investment mismanagement. Fiduciary liability is not determined by investment performance, but rather on whether a prudent investment process is followed.
Formalizing an Investment Process
FI360 defines four major steps in an investment process, Organize, Formalize, Implement and Monitor. In the Formalize stage you, the fiduciary must understand the principles of asset allocation because, by law and regulation, a prudent expert is clearly expected to understand modern portfolio theory and apply generally accepted investment principles. The fiduciary must also prepare an Investment Policy Statement to guide the remainder of the investment process. And finally, at this stage consideration should be given to whether socially responsible investing will be used in constructing the portfolio.
An investment policy statement is considered the business plan for the process. It formalizes your decision-making on time horizons, expected returns, asset classes, what investments to include, when to replace an investment, etc. The Center for Fiduciary Studies has defined Twenty-two practices that detail their idea of a prudent investment process for you and your retirement plan. If you would like to more about their process, you can go direct to www.fi360.com, look for an Accredited Investment Fiduciary®, Accredited Investment Fiduciary Analyst® or Professional Plan Consultant™.
(1) The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
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