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What to Expect from Your Investment Consultant: Understanding the Relationship

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Nonprofits with assets to be invested often choose to employ a third-party consultant to oversee their investment program. This four-part guest series from Cornerstone Management highlights key items nonprofits should be aware of when working with an investment consultant. Understanding these issues will help your nonprofit have a fruitful relationship with your investment consultant.

Fiduciary Status

In a particular relationship, an investment consultant may operate in either a fiduciary or a non-fiduciary capacity:

  • Fiduciary – A fiduciary relationship entails a higher standard of care and involves the consultant acting as a co-fiduciary with the nonprofit. Fiduciary relationships require that the consultant’s recommendations and actions are not just appropriate but also are in the client’s best interest. In a fiduciary relationship, the consultant is typically responsible for ongoing monitoring of the investment portfolio and for placing trades. Additionally, fiduciary relationships require a duty of loyalty, which includes the disclosure of possible conflicts of interest.
  • Non-fiduciary – A non-fiduciary capacity represents a lower standard of care than does a fiduciary capacity. This lower level of accountability is based on the suitability standard, which simply requires that investment recommendations and actions are appropriate for the client. In a non-fiduciary relationship, the consultant typically makes recommendations to the client but does not maintain daily oversight of the investment portfolio. The consultant typically does not place trades, either. In short, a non-fiduciary relationship generally involves a less “hands-on” approach.

To ensure that investment portfolios have the desired amount of coverage and oversight, nonprofits should clarify with their consultants which type of relationship is in place.

Conflicts of Interest

Investment consultants are in a position of trust and must put their clients’ interests before their own. A few potential conflicts of interest may exist in a relationship with an investment consultant:

  • Proprietary (“in house”) products – Consultants may be inclined to recommend investment products managed by their own firms. There is an incentive to recommend these products because they will generate additional revenue for the firm.
  • Compensation from products – If consultants receive compensation (e.g., a referral fee, commission, etc.) from third-party investment products, the consultant will also have an incentive to use these products in client portfolios.
  • Soft dollars – In exchange for trading through a particular broker, consultants may receive credits or discounts toward purchasing research. This type of arrangement is known as “soft dollars.” A consultant may prioritize trading through brokers who provide soft dollars over those who provide superior execution.
  • Trading and billing mistakes – Consultants should maintain a set of procedures for identifying trading and billing mistakes. Just as important, the consultant should maintain procedures for correcting mistakes that ensure the client will be made whole.

While the points above may seem concerning, many firms do an excellent job of managing these potential conflicts of interest. Consultants understand that they are in a position of trust and take the responsibility seriously. That said, we believe nonprofits must discuss potential conflicts of interest with consultants and understand how any concerns are eliminated or mitigated.

Up Next

In the second post, we will discuss investment philosophy and investment policy along with the consultant’s role in developing these documents.

 

About the Author

Winters Richwine is Chief Operating Officer and a Principal of Cornerstone Management. In this role, he develops and implements firm initiatives regarding process and efficiency and supports the portfolio management and charitable trust tax teams.

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