Fiduciary Standard
As an independent fiduciary (an independent registered investment advisor), we are legally required to work first in our clients’ interests before any other party’s interests, including our own. In addition to having a legally-defined duty to serve our clients’ interests, a loyalty shared by lawyers and certified public accountants, our interests are aligned with our clients financially. Our revenues rise and fall with our clients’ assets; in other words we are paid better only when our clients are paid better. This is important because there are two powerful forces that cause most investors to experience low returns: investors are their own worst enemies and the firms they work with may not be working in their best interests.
Unfortunately, investors face a difficult environment that has historically caused them to substantially perform market returns. This problem occurs because investors are their own worst enemies, they buy high and they sell low. It is exacerbated because most investors work with an advisor who is not legally obligated to work in investors interests at all times. In the worst case scenario, the investor is urged to work against his own interests by his advisor who may be working in his own interests instead of the client’s.
Investors are their own worst enemies. Study after study shows that both equity and fixed income investors experience worse returns than comparable ind ices. We understand that, in order for our clients to realize the benefits of a long-term investment strategy, there will be volatility. When this volatility occurs in our client accounts it means our fees rise and fall, so that we suffer directly with our clients during downside volatility and are rewarded as accounts appreciate. Since we are capitalists, our clients can rest secure that we believe our advice is in their long-term interests, because we will suffer and prosper equally on the journey.
The firms most investors work with may not be working in clients’ best interests. Most financial services companies are publicly traded. The goal of publicly traded companies is to make money for shareholders not to make money for clients. While these firms may argue that is how they make money for shareholders, we find this argument highly contentious. Clear conflicts of interest exist those, while fully disclosed, are generally poorly understood by most investors. For example, according to a Cogent study in 2004, over 75% of investors use an advisor who may legally put his own interests and the interests of his firm above the interests of his clients. If the advisor is not a fiduciary, he may legally advise his client to buy a product that is in the advisor’s best interests and his firm’s best interests, but that may not be in the client’s best long-run interests.
Standard industry practices we feel are problematic include revenue sharing, a practice where firms require investment managers to pay for shelf space in order to be offered by the broker. Often unwillingness to pay precludes inclusion on the shelf. Another practice is the practice of contingent deferred sales charges (CDSCs). CDSCs are commissions that are not charged when an investment product is purchased, but that may be charged if the investment product is redeemed within a specified time period, which may be from 7-12 years.
In addition to the publicly traded firm issue and standard industry practices, advisors are under a lot of pressure to hit targets. For advisors to advance through the ranks, to keep a job and earn titles like Vice President, they have to reach performance targets. Even worse, once an advisor has reached a level where he has a stable client base, he becomes an attractive target to woo to other firms. Other firms make very enticing buy-out offers often as much as 5 times the advisor’s income for an advisor to switch firms. These buy-out offers are often contingent on the advisor continuing to produce (to charge fees and commissions). Especially in environments where stock markets are doing poorly there is substantial pressure to generate commissions to make up for lost revenues charged on higher asset values. This pressure may be exacerbated after an advisor switches firms.
The worst case occurs when the investor is allowed to be his own worst enemy by an advisor placating the investor’s need for comfort. This generally occurs when an investor is most susceptible, after the stock market has suffered a serious correction. For example, in March of this year, when the S&P 500 was trading in the upper 600s, we met a prospe ctive client who was sold a fixed annuity. This occurs regularly as advisors sell clients certificates of deposits, variable annuities, whole life insurance and other products that on closer examination do not meet with the clients’ long-term goals. These practices are legally defensible because all investors have differing tolerance for risk, but are almost certainly not in the client’s best interests if we assume that long-term trends will hold, i.e. that in the long-term the global economy will continue to grow and that shares of good companies will appreciate more than inflation.