Guest Article

Bettering the Odds For Investment Committees

By Jeb Graham CEBS, CIMA® of CapTrust Financial Advisors, an independent consulting/advisory practice focused on the institutional retirement plan market, serving corporate, closely held, non-profit and governmental organizations. You may contact Jeb at 813.218.5008 or jeb.graham@captrustadv.com.

So if one buys into the "form of gambling" notion, can the odds for success be improved? Pick up any financial publication and it will be filled with ads touting investment managers and their returns over specific periods, or how many stars a rating service gave them. Pick up the phone and call any bank, brokerage firm, insurance company or mutual fund and ask them if they can advise you on investments. Throw in the trust factor for an industry awash with recent scandal, and what do you have? More noise than an elementary school cafeteria.

Given that investment committees are by law held to certain standards of prudence, and that most committee members are intelligent men and women with expertise in areas other than investments, the challenge in fulfilling their obligation is significant. By virtue of decision-making responsibility, most of these committee members are now plan fiduciaries…that unknowingly inherited that role. So how do these individuals tune out the noise, make prudent decisions and avoid the inherent risk that comes with the new territory?

Intuitively, the logical focus is on picking funds or investment managers. Or to get someone they trust to pick for them. Committee members often have worked with advisors on either their personal assets or other company business …and although the results may be mixed, the success of the relationship is based on personal trust. This trust is typically the dominant factor in the relationship because no other form of measurement has been established.

If and when an investment committee determines the need to hire an advisor, they are obligated as fiduciaries to conduct appropriate due diligence in the hiring process. One of the most common mistakes committees make is selecting the advisor based solely on trust, without appropriately examining the qualifications. If a person or team does not have experience in both investments and qualified plans, one could question whether the fiduciaries conducted appropriate due diligence.

Institutional vs. Retail

In our practice, we profess to take an institutional approach to investment consulting. When asked what this means, the response is to offer a contrast to what we refer to as a "retail" approach in which someone is selling a product…a particular fund manager or investment platform. The retail broker or advisor uses his or her expertise, or the home office research department, to select the best products to sell. There is absolutely nothing wrong with this approach…for individual investors. Measurement and documentation are less important than the relationship.

The institutional approach is process driven, rather than product driven. The investment committee for a company 401k plan or for a charitable foundation is acting in a fiduciary capacity…meaning they are responsible for the investment decisions made on behalf of other people. Fiduciaries are held accountable for the decision-making process rather than the results they achieve. In other words, it's not whether you win or lose its how you play the game. The way I explain this to prospective clients is the difference between telling a committee you will pick the best funds, as opposed to stating that you will help them implement and carry out a process that ensures fiduciary best practices.

Although the underlying goal of making money for clients may be the same, there are more than subtle differences between the two approaches. If a committee implements and diligently follows processes that are indeed based on fiduciary best practices, there can be a greater expectation of more positive long term results. That is a simple law of nature. The challenge is getting to and maintaining best practices. And that is where we believe an institutional consulting approach makes a difference…a difference that can impact the plan participants.

Finding the Right Advisor

Since most committees do not have the time or inclination to be investment experts, it makes sense to engage a third party in an advisory role. In the selection of the advisor, certain factors listed below matter…a lot.

• Expertise and experience. Some advisors are strong on the investment side. Some have strong backgrounds in the qualified plan area. Very few have both. A plan committee selecting an advisor would be well served to engage a third party with expertise in both areas.
• Objectivity. Independence matters. Conflicts of interest are real and should not be confused with personal integrity. There are many individuals with the highest level of personal integrity that happen to be employed by or otherwise affiliated with a firm that represents a potential conflict of interest for an investment committee. You don't want to pay the fox to guard the henhouse.
• Fees. While fees should never be the primary indicator, they do matter. The challenge facing plan fiduciaries is to understand fees in a relative sense, in terms of value being received. The problem is twofold: fee structures are often complex and confusing; and, the criteria used to measure value being received are inadequate. Disclosure is also an issue. A committee should insist that fees are disclosed in a service agreement, as opposed to the advisor being paid a commission or 12(b)1 fees from mutual funds, or some other type of soft dollar revenue.
• Organizational depth. The size of the third party providing advisory services can be misleading. Large national firms may have lots of expertise, but the real question is one of resource allocation at the local level. A small consulting shop may offer very customized service, but scale and capacity may be a concern. The ideal third party is probably somewhere in the middle… unless the goal is looking for the deepest pockets.
• Role as fiduciary. A committee engages a third party to provide investment advice. The third party advisor should be willing to accept a fiduciary role in writing. It's that simple. If the advisor is unwilling to accept that role, the committee should remove them from consideration.

Conclusion

Art or science? Pure chance or process and strategy? Can investment committees better the odds for success? I believe the answer to clearly be yes...if prudent process is combined with good common sense. But with all the noise in the world of investments and the potential conflicts of interest that exist, it is easier said than done.

This material is distributed solely for information purposes and is not a solicitation of an offer to buy any security or instrument or to participate in any trading strategy. The views contained herein are the opinions of the author. It is not intended as legal or tax advice. CapTrust Advisors, LLC is a Registered Investment Advisor with the SEC. CapTrust is not a legal or tax advisor.

Other articles by Jeb Graham: Looking Under the Hood of Your 401k to Understand the Real Costs, Does Your Organization's Retirement Plan Measure Up? and The Importance of Legal Counsel Review.

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