When is Advice Independent?

This article looks in detail at the perils and pitfalls of not taking independent investment advice for your charity, and gives you the six key areas of focus which define that independence.

Recently a friend of mine asked me to look over some documents sent from his investment manager for the charity that he was running. I found myself in the delicate position of suggesting that the advice was possibly not in the best interests of the charity at that time. This led to a long discussion, but also had me wondering how many more organisations receive advice from their investment manager which is both truly independent, and in the best interests of the organisation.

Why do so many investment managers wear the two hats of both providing advice, whilst at the same time managing the funds?

It also made me question why there are so few independent advisors to the charitable sector when the Charity Commission is quite clear in CC14 ( about the need to take independent advice.

So, back to my friend and his request. The first question I asked him was how well the suggested investment strategy fitted with the strategy and direction of the organisation as a whole.

His answer was revealing, “I’m sure that they have thought about this, however now that you mention it, this is not stated anywhere in the documentation, it is just implied throughout.”

So the first question to ask your investment manager is “How does the strategy you are operating fit with my organisation’s overall strategy and future requirements?” If they can articulate the latter with the former in mind then you are on to a winner.

The problem is that most investment managers actually do stick to their own familiar tried and tested models and calculations, but make little effort to be driven and informed by the organisation’s strategy.

Try it and see what the results are. Your investment strategy could indeed be completely the wrong strategy for your organisation.

The second thing to consider is how the investment has been structured.

My friend’s advised portfolio structure was a very traditional one - 70/20/5/5 equity/bonds/alternatives/cash. I asked him why the alternatives were there, and why his investment manager wanted him to increase them. As most people would, he gave the investment manager’s reply - to dampen down volatility and ensure that the portfolio did not underperform in the short term. After all it had been a successful strategy implemented by the Yale Endowment.

However, because of the alternatives being illiquid, Yale had in fact seen one of its poorest performances during the early stages of the recession, poorer even than traditional charities.

The second question to ask is “How liquid are the alternatives, and could I retrieve my money immediately if I wanted to?”

I have heard two answers. The assets are there to dampen down volatility, so why would you want to do that, and besides they are there for the long term. And the second is that withdrawal might take a few days and you could take a loss on them. So now we have established that the alternatives are not quite the same as equity, bonds and cash.

When my friend asked this question he was shocked to find out that not only were the assets illiquid, but sure enough, there might well be a liability with some of them.

Now he did admit that when the investment manager had discussed alternatives with him he had found it a little difficult to understand exactly what they were and how they worked. But now that he was clearer, he questioned the logic of holding them, especially when he considered other issues around transparency, costs, the ability to sell, and more importantly, what the alternative may be invested in.

I wondered why my friend did not consider taking independent advice when setting up his charity’s investment strategy. The response he gave was one I hear time and time again from the sector. The trustees discussed the matter with the investment manager who presented the strategy and advice. They did not feel it was necessary to seek outside advice and did not want to incur any further costs.

Understandable. However as with all professionals, the investment manager is looking to retain his relationship with his client (which may have existed over many years), and the client may not wish to go out of their comfort zone. The result is advice that may well be sound, but not independent.

So what benefits does independent advice bring to the equation? In a simple answer it challenges the norms. The areas of focus for independent advice are: 

  • Ensuring the investment strategy is aligned with the organisation’s strategy
  • Putting in place appropriate benchmarks to monitor the short and long performance of the investment manager
  • Consideration of the asset allocation and risk to achieve the required results
  • Understanding of the ethical implications of taking advice from the investment manager, how to cater for this, and understand the issues that may result
  • Reviewing transparency of the fee structure of the both the investment manager and any funds that they may be using
  • Consideration of the entire market place when selecting who would be best suited to manage the strategy and funds on behalf of the organisation.

This also led me to ask why there are not many advisors to the charity sector, when there is no shortage at all of independent financial advisors for individuals! One reason is that the sector has not seen a need for this, as investment managers themselves have undertaken this role for them. The other is that there are few truly independent advisory organisations – by this I mean those not operating funds of their own and not tied to a group of funds.

So back to my friend. After a little assistance and advice we were able to turn the situation around, both retaining the investment manager and going forward with a strategy much more suited to his organisation’s strategy, with asset allocation that did not have wild or unusual alternatives and less volatility.

But more importantly my friend felt more confident in how the investments were operating and in the advice of investment manager.