Due Diligence

Over the last decade, the financial services industry has become increasingly complex and confusing. The main reason pertains to a blurring of responsibilities and expertise among financial professionals. This occurred as banks bought brokerage and investment management firms. Insurance companies merged or were acquired by banks. In a few instances banks owned both brokerage and insurance operations.

Along with all the mergers and acquisitions was the proliferation of titles and designations that include financial planner, financial consultant, financial advisor, and wealth manager, to name a few. Professional designations and degrees include CPA, CFP, ChFC, CLU, MBA, CFA, and PhD. All of the preceding designations may be involved with investing in one form or another. This could include the sale of financial products to the sale of nothing (i.e., pure investment management or asset management). CFA is a recognized designation among professionals involved with investment management. Three rigorous exams over several years must be passed covering portfolio theory, security selection and evaluation, and ethics. Ideally, one member associated with a firm has the designation. Educationally speaking, an MBA or equivalent is most relevant. If a firm has a PhD in Finance, all the better.

In our professional opinion, if you are searching for an independent financial professional that will be dedicated to protecting your best interests, you must search for one who sells nothing and charges a fee to manage your investment account. Beyond the question of fee for service, one must know what questions to ask which may include:

  • Is your firm a “Registered Investment Adviser” with the U.S. Securities and Exchange Commission? All independent investment managers that manage more than $100 million in the U.S. must be registered with the S.E.C.
  • If “no,” then ask “why not?”
  • If “yes,” then ask for FORM-ADV. FORM-ADV is a part of the advisers registration information provided to the S.E.C. FORM-ADV Part 2 must be given out to all prospective clients. It is the most important document that you can obtain from a “Registered Investment Adviser.” Part 2 tells you how the adviser earns his compensation, clients served, investments selected, fee schedule, and any conflicts of interest. FORM-ADV Parts 1 and 2 can be found on the S.E.C. website. It highlights fines paid, enforcement actions against the adviser, assets under management, and principal shareholders and their backgrounds.
  • Ask if the investment manager maintains investment performance statistics for all the accounts being managed. This item is as basic as apple pie when searching for a professional money manager. If the firm is not measuring their performance and comparing it to some benchmark of excellence, then you are not meeting with a professional investment management firm.
  • Closely tied to question (4), are the firm and its performance composites “GIPS®” compliant? GIPS stands for Global Investment Performance Standards. GIPS are worldwide standards developed to ensure that all professional money managers measure their performance using the same methodology, the same presentation format, the same disclaimers, the same internal controls, etc. This ensures a fair and honest comparison without smoke and mirrors. It levels the playing field and eliminates playing deceptive games with the numbers.
  • If you are GIPS compliant, are your composites audited? It is one thing to say you are GIPS; it is quite another for an independent auditor who specializes in GIPS compliance to confirm that in writing.
  • Are you willing to provide references? Two or three names are inadequate. Two or three pages of names would be more acceptable. A common comment from advisors is that we sign a confidentiality agreement with all our clients and cannot release any names. That may be a true statement, but clients can agree to serve as references in writing for any firm.
  • Ask the adviser if 100% of his revenue is earned by providing “investment supervisory services.” If “yes,” then you have found a specialist that devotes 100% of his time and resources to growing various types of investment accounts to higher values. Since you already selected someone who is “fee only,” then they benefit when you benefit.

Make sure that the adviser is not also the custodian holding your funds. The custodian should be someone independent of the adviser, like Fidelity or Schwab. Finally, never give full Power of Attorney to any money manager, all they need is limited discretion to manage your account somewhere. Without P.O.A., the adviser cannot invade your account or move it without your knowledge.

It is impossible to cover all the elements on a page of this length. What we have shared with you are some of the basics of qualifying a professional independent money manager who will be dedicated to working for you.