Editor's note: What follows is an excerpt. Click here for the full version of this article, including an investment policy statement checklist for fiduciaries.
The skillful construction of a retirement plan's investment policy statement involves a number of considerations. For example, ERISA's investment provisions require that fiduciaries apply prevailing investment industry practices. That would include, for example, considering both qualitative and quantitative factors when selecting, monitoring and removing an investment.
The implementation of the IPS requires diligence by plan committees in meeting and applying the criteria to the investment options offered to the participants. For example, a material change of a portfolio manager requires that a committee consider the impact of the change on the investment, determine whether that change could adversely impact the quality of the investment and evaluate its potential consequences for the participants.
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A committee's investment process should also include information and advice that enables the committee to identify those circumstances that, for one reason or another, raise questions in the minds of the committee members. Once a committee identifies a material issue, the investment is placed on the watch list for further investigation – or, in other words, to be watched.
There are a number of issues that can raise important questions, questions that are material enough to warrant more attention than ordinary monitoring or, stated differently, important enough to place the investment on the watch list. Among the most critical are:
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The portfolio manager and the investment firm were initially selected for a reason. Has that changed? Was the investment firm or portfolio manager selected for its reputation? Has something changed such that the initial reason for selection may no longer be valid?
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Has the individual portfolio manager (or a lead portfolio manager of a team) left the firm? Obviously, the greater the influence of the departed manager over the investment strategy or investment selection, the greater the potential impact of the departure.
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Has there been significant change or turnover in the investment firm's staff –and particularly among the analysts and portfolio managers? While the individual portfolio manager may be the face of the organization, a successful investment program is dependent on its analysts and support team. Departures and turnover can adversely affect the firm's investment process.
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Have there been substantial outflows from the investment? Material changes to the amounts invested — and particularly outflows — can be disruptive to the portfolio manager's investment process and may result in the liquidations of investments at inopportune times. Those events may adversely affect the investment results for the participants.
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Are there regulatory investigations of the investment firm? An examination by a regulator, such as the Securities and Exchange Commission, may or may not reflect any wrongdoing. But, until the outcome is known, there is some risk. Also, the investment firm will need to devote resources to the examination, which may be a distraction from the portfolio management.
Putting an investment on a plan's watch list is only the beginning of a prudent process.
Once an investment is on that list, the committee needs to:
"Watch" (that is, to investigate) and make a decision about whether to retain the investment—and remove it from the watch list — or …
"Fire" the investment manager (by removing the investment option and replacing it with another in which the committee members have more confidence).
How does that decision get made?
The simple answer is for the committee to engage in a prudent process for that purpose. The more detailed answer is for the committee to investigate the issue that raised the concern by gathering the information that a prudent, or knowledgeable, investor would want to review in order to make the decision. As a practical matter, most committees will probably want to have their investment consultant or advisor handle the investigation – and then report to the committee.
Two key elements of a prudent process are:
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Gather and evaluate the "right," or relevant, information.
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Consult with a qualified investment consultant or advisor.
The financial advisor should be helpful with both determining what information is relevant and how to properly evaluate that information.
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