Investments are the easy part
When a person agrees to be a fiduciary, it is often based on a self-assessment of two criteria: first, I am trustworthy, and second, I understand investments. These facets are certainly important. If you sit on an investment committee for a charitable organization or corporate retirement plan, you should be trustworthy. Furthermore, a lot of the decisions you’ll be making involve hiring investment managers and allocating assets, so it would be helpful to know something about investments.
Understanding investments is a good first step to becoming a fiduciary. However, investments are the easy part. It is the other parts – the legal and ethical aspects to being a fiduciary – which are more difficult to manage. Why?
For starters, there is a relative lack of understanding of legal issues relative to investment issues. After all, nearly everyone has a bank account and most everyone can manage their own finances. Most professionals will have some investments experience, either through their personal retirement assets, their children’s college fund, or other assets. On the other hand, the concepts which inspire confusion for investment committees and plan sponsors, lack this natural familiarity. Words like “stewardship”, “governance”, “prudence”, and “compliance” can feel like meaningless buzzwords with only hazy definitions.
Another problem with managing the legal aspects to being a fiduciary is there are simply fewer experts to draw upon. There are thousands of people with substantial investment experience including old-fashioned stock brokers, day-traders, financial analysts, wealth managers, family offices, accountants, and so on. Conversely, there are very few professionals who tailor their investment recommendations to the legal requirements of a fiduciary relationship.
On the plus side, there is nothing inherently difficult about any of this. Everything fits inside the basis of common-sense. Still, nobody is born knowing all the details, so it takes a little education or training to fully acknowledge the duties a fiduciary accepts.
To begin facing this challenge, we will solidify these nebulous concepts into something meaningful. Today, we will start with “stewardship”. A fiduciary, almost by definition, manages the assets for the benefit of someone else. The concept of stewardship refers to the appropriate management of resources which do not belong to you.
So, how does one demonstrate they are a good steward? Consider a charitable organization like Habitat for Humanity. In order to attract donations from the community, the charitable organization must show the money they raise goes to support the intended mission (in this case, affordable housing). To maintain their donors’ goodwill, they must show the success they have had supporting this mission. In short, they must demonstrate the goals of the organization are efficiently being served with the limited resources they have been entrusted with.
There are behavioral aspects to stewardship which must be accounted for, particularly in regards to the investment selection. At some level, every investor is risk-averse and must be compensated for adopting investment and market risk with commensurate returns. Risk aversion is a healthy and necessary component to investment behavior. However, a steward often exhibits a heightened sense of risk-aversion while directing the investments for other parties. This natural conservatism of stewards can manifest itself positively as a thoughtful and prudent investment lineup. For example, good stewards avoid speculative or whimsical investments. On the other hand, a steward’s cautious tendencies must be balanced against the ultimate goal – the mission – of the assets. Stewards are occasionally too conservative in their approach and end up constructing an investment portfolio which cannot reach the investment target returns even given ideal circumstances.
Please read our “9 ½ Questions” feature for additional perspective on good stewardship and how it applies to different pools of assets, like pension or defined contribution (i.e. 401(k)) retirement plans.
Stewardship is only one element towards understanding fiduciary responsibility. Other elements - including duty of loyalty, governance, transparency, prudence, and diversification - should be discussed with your fiduciary consultant. In future editions of Confero, we will explore these concepts and provide more education and insight.