More Than Money
Issue #25

Working with Financial Professionals

Table of Contents

“Managing the Managers”

"Critical to the evaluation of any manager's performance is the creation, at the outset of your relationship, of an Investment Policy Statement, clearly establishing your financial and social goals and an agreed upon strategy for achieving them."

Lay of the Land

Ah, yes, the bottom line. How do you evaluate investment managers' performance? Can you get help to monitor your managers? At what points do you have reason to express concerns-and when would you fire someone? This article sums up some guiding principles offered by several experienced investment consultants.

When it comes to evaluating performance in a financial advisor, there's oversight as a noun ("letting my manager invest 15 percent of my portfolio in one company was an oversight") and oversight as a verb ("I'll never be an expert on mid-cap international offerings, but if I don't oversee this manager's performance relative to his peers, who else will?). Just as the parts of your portfolio subject to frequent monitoring and strategic change are considered to be under "active management," money managers are most likely to adhere to your goals when they are under your active oversight.

Critical to the evaluation of any manager's performance is the creation (at the outset of your relationship) of an Investment Policy Statement, clearly establishing your financial and social goals and an agreed upon strategy for achieving them. Typically such statements stipulate guidelines for asset allocation and set benchmarks for performance, usually pegged to the same investment style indices.

Accounts & Accountability

Until the 1990s, primarily only institutions and individuals of very high net worth made use of professional portfolio managers. Today, thanks to sophisticated computer tracking programs and the burgeoning growth of the investing class, individuals with as little as $250,000 can avail themselves of an array of money management services focusing on socially responsible investment. Even at that entry level, it is now increasingly common practice to engage multiple managers who are good at different management styles in order to diversify effectively and reduce risk to your portfolio. The primary management styles to choose among are growth (selecting high growth stocks, often at a high price), value (selecting stocks that appear undervalued by the market), core (a combination of growth and value), international, and bonds. Additional diversification is realized through varying the market capitalization of stock, i.e., large, mid, and small cap stock.

Given the new multi-manager model, many people wonder how to interface well with their managers. One can deal directly with small advisory firms who custody their accounts at large full-service institutions or one may hire in-house managers at one of the large institutions themselves. Increasingly, however, a second tier of financial professionals is emerging, who are sometimes called "investment management consultants" or "managers of managers." One can hire such a person up front, and he or she can help you with your investment policy statement (to formulate, implement, and monitor it), as well as with your managers (by hiring, overseeing, negotiating fees with, and, if necessary, firing them).

A hybrid option is now being offered by large firms in which oversight is provided in-house. At the low end of the asset spectrum, starting at $250,000, this takes the form of a "wrap account" in which a flat fee covers all management and transaction costs. Clients select from among a small pool of in-house portfolio managers and interface exclusively with a supervising financial consultant who acts as a planner and a manager of managers.

Beginning at the $1 million level, an investor may choose an alternative to the wrap fee structure, and work with what's considered a more conventional fee plus commission structure. Here the management fee is lower, but the client assumes transactions costs. The pool of managers from whom one can choose increases tenfold (including non-staff managers) and the client retains the right of direct access to them. In this arrangement, the supervising financial consultant serves as a second layer of oversight, while the client reserves the right to do his or her own due diligence.

What if one has not engaged a consultant up front, but at some point down the line wishes to review the performance of a manager? One-shot consultations are available at full price from full-service firms: one charges $5,000 per manager. A cursory review of a portfolio could take as little as two-three hours, while in-depth interviews with each manager could take a couple of days. It is not unusual for a client to ask one money manager to review the work of another (for example, to evaluate a portfolio for companies that don't pass a set of social screens). It is increasingly common to engage a consultant manager of managers to consult on an ongoing basis, especially since an annual review is prudent anyway and any incremental increase in expense is often negligible.

Red Flags?

Itching to fire your money manager purely for underperformance? Relax, haste may make waste. For one thing, most financial professionals recommend giving managers at least two to three, and ideally five years, in which to demonstrate their abilities. In addition to potentially better performance, one of the primary benefits of having your assets managed individually is increased control over the realization of capital gains taxes. Investors who put their money in mutual funds are typically at the whim of the portfolio manager who is not looking at your individual tax picture. Excessive changing of investment advisors can be extremely tax inefficient.

You probably want to cut your managers up to 5 percent slack in underperformance for a couple of years (relative to pre-established peer-group indices) before stepping in with the tough questions. A 15 percent underperformance relative to the benchmark over two years, however, could constitute clear grounds for going elsewhere. Line up a new manager before terminating the first. In dire circumstances, give the manager immediate written notice to freeze the account until further notice to give yourself time to make alternative arrangements.

Thanks to the following for advice on this article:
David Crocker, Sr. VP at Solomon Smith Barney
David Hills, Sr. VP, Investment Management Consultant, A.G. Edwards
Lisa Leff, Senior Portfolio Manager, Trillium Asset Management


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