best practices for the selection and monitoring of investment service providers

© 2013 fi360 Inc. All Rights Reserved. 2

Best Practices for the Selection of Investment

Service Providers

Blaine F. Aikin, AIFA®, CFA, CFP®

CEO, fi360blaine@fi360.com

3© 2013 fi360 Inc. All Rights Reserved.

Topics

• The fiduciary standard as the basis of procedural prudence• A process-driven approach to due diligence• Service provider selection generally• Investment due diligence

Note: We will reference the Prudent Practices Handbook for Stewards during this discussion

4© 2013 fi360 Inc. All Rights Reserved.

Duties Associated With the Fiduciary Standard

Fiduciary Standard

Duty of Loyalty

Avoid/Manage Conflicts

Disclosure Proxy Policy Principal Trades

Suitability

Both Duties of Loyalty and

Care

Best ExecutionReasonable

Fees & Expenses

Duty of Care

Safeguard Client Assets,

Privacy

Procedural Prudence

Due Diligence Monitoring Record-Keeping

Global Fiduciary Precepts

1. Know standards, laws, and trust provisions.2. Diversify assets to specific risk/return profile of

client.3. Prepare investment policy statement4. Use “prudent experts” and document due

diligence5. Control and account for investment expenses6. Monitor the activities of “prudent experts”7. Avoid conflicts of interest and prohibited

transactions

Establishing “Reasonable” Service Provider Relationships

• A service agreement isn’t reasonable if you don’t know the service provider’s– services– compensation arrangements– fiduciary status

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Delegation Requires Care, Skill, and Caution in…

• Selecting an agent• Establishing the scope of the engagement• Monitoring the agent’s performance and compliance

with terms of the engagement• Setting fees

Benefits of Effective Due Diligence

• Make good service provider selections• Delineate roles and responsibilities• Reduce regulatory and litigation risks• Serve the best interests of beneficiaries through

fiduciary excellence

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Role and Responsibilities of Financial Intermediaries

Product Originator Traditional Broker Adviser

counter-party agent fiduciary

manufacturer salesperson professional

opposite side of table intermediary same side of table

buyer beware buyer be aware trust assumed (verify)

“product safety” fair dealing best interest

rules-based rules-based principles-based

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Four Step Service Provider Selection Process

1. Define the services (benefits) to be delivered2. Identify providers capable of delivering the desired

services3. Evaluate the capabilities of competing providers to

deliver the services at a fair and reasonable cost4. Engage and monitor the top-ranked provider

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Best practices

1. Apply a formal Request for Proposals (RFP) process2. Monitor service provider relationships regularly

a. monitoring of investment managers is ongoingb. other service provider relationships should be evaluated

approximately every three years

3. Replace service providers when you no longer have confidence in their ability to most effectively and efficiently perform the services for which they were hired

4. Typically, selection and monitoring criteria are the same

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Hierarchy of investment decisions

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Five Fundamental Principles of Prudent Investing

1. Prudence standard is applied at the portfolio level2. Risk/return tradeoff is the central consideration3. No investment is inherently imprudent4. Diversification is required, unless it is prudent not to do so5. Delegation to prudent experts is permitted/encouraged

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Common Due Diligence Criteria

• Risk-adjusted returns• Returns relative to peer group• Portfolio composition• Style consistency• Expenses• Management tenure• Product inception date and assets• Qualitative factors (e.g., support)

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Complex Investments Involve Additional Due Diligence

• Regulatory oversight• Firm background• Investment methodology• Risk management process• Management/personnel• Compensation/fees• Reporting capabilities• Recommendations from third party expects

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Substantive and procedural prudence

I know of no case in which a trustee who has happened—through prayer, astrology or just blind luck—to make (or hold) objectively prudent investments ... has been held liable for losses from those investments because of his failure to investigate and evaluate beforehand. Similarly, I know of no case in which a trustee who has made (or held) patently unsound investments has been excused from liability because his objectively imprudent action was preceded by careful investigation and evaluation. In short, there are two related but distinct duties imposed upon a trustee: to investigate and evaluate investments, and to invest prudently.

- Judge Antonin ScaliaFink v. National Savings and Trust Co.

© 2013 fi360 Inc. All Rights Reserved. 17

Questions?

Blaine F. Aikin, AIFA®, CFA, CFP®CEO, fi360

www.fi360.com