Welcome to this week’s INFREQUENTLY ASKED QUESTION: What Do I Need to Do to be a Good Fiduciary to My Clients?
As Faith-Based advisors, we are very focused on the screening component of our portfolios. As a result we may minimize or dismiss some important components of our fiduciary responsibility to our clients. It’s crucial to address both as we strive to glorify God and to fulfill our fiduciary obligation.
Hillary Sunderland, CIO, CFA, CKA, reminds us of some critical factors we should be monitoring in addition to values screening.
Full transcript below.
Transcript
Cassie Laymon:
Hi, Hillary, it’s good to be with you today.
Hillary Sunderland:
Thanks, Cassie. Great to be with you.
Cassie:
Well, we are going to talk about another infrequently asked question today, and that is: what do I, as an independent advisor, need to know about being a good fiduciary to my clients? And I’m going to just admit this was not something that was on the top of my list of things I was thinking about when I became a financial advisor. So just for starters, can you tell us what your definition is of fiduciary?
Hillary:
Sure. Well, a fiduciary to me is someone who takes on the responsibility of selecting and monitoring plan investments, really in the way that any prudent person would do. And so, as it comes, you know, as it pertains to the BRI [Biblically Responsible Investing] industry, I think it’s important to remember. It goes well beyond how are you actually screening the portfolios? You need to be constructing portfolios prudently. And so, you need to follow the same due diligence process that any competent manager would follow for their portfolios as well.
Cassie:
So, I’ve been pretty transparent about my journey in BRI and I wasn’t always necessarily thinking about the part about being a fiduciary, even though I’ve always felt very responsible. And I would say, you know, it doesn’t matter if the fees are higher or if the performance lags, because we’re glorifying God with our investments. And so, we agree that we always want to glorify God with our investments, but could you just talk about, do you agree with that approach or in what ways do you not agree with that?
Hillary:
Well, I think you bring up a great point, Cassie, you know, part of being a fiduciary is, you know, managing the investments that God has entrusted to our clients the same way we would manage it for any other person, whether or not they want to invest with a values-based criteria or not. I will say though, however, over the last five to 10 years, especially there has been an enormous increase in the number of BRI oriented products available to the marketplace.
And so, I think kind of hidden in that question you just asked was the notion that, well, the fees are going to be higher and the performance is going to lag. And I would say, that’s really not the case. As we’ve seen more things come to market what we’ve found, there’s been study after study done on this and what these studies have found is that when an investor, it puts their investment portfolio in a line with their values it doesn’t detract from performance at all. In fact, some studies say it’s actually additive to performance.
And so, I don’t think that we should, you know, make the assumption that the performance is going to suffer because we’re doing BRI. You know, in any given type of market environment, a particular investment strategy could go out of style. It could go out favor with the broader market, but over longer periods of time studies show that it should keep pace or even outperform a secular type portfolio given the market environment. And so, while the screening is important and the fiduciary aspect is also important to building portfolios for our clients, I think it’s important to note that that doesn’t necessarily mean that fees will be higher or that the performance will suffer because of it.
Cassie:
Okay. So, I want to tie these things together, the screening and the fiduciary piece together. So, we talk to advisors sometimes who say, well, I look for a screened investment and I look at the performance and that’s how I choose my investments, or that’s how I build my portfolio. So, can you just talk about some things because a lot of folks that are listening are probably not CFAs, right? That’s not my background. So, what are the important things that I should be paying attention to so that I can be a good fiduciary to my clients?
Hillary:
Sure. That’s a great question, Cassie. And one that I get a lot, as well as the portfolio manager, you know, there, there’s several things to look at in addition to looking at performance of a mutual fund or ETF versus its peer group versus the benchmark and risk adjusted returns. There’s a wealth of other things that you should be looking at when deciding whether or not to incorporate something into your portfolio. So, you know, stability, the organization who’s actually managing the portfolio. Are they in good standing under the regulatory environment that we’re in?
Certainly looking at fees, how do the fees impact what you’re doing for the client? I think this is often a very overlooked part of investing. You know, you need to be looking at proper share class selection. Sometimes advisors will go right to, well, I’ll just buy the institutional share class because it’s the cheapest net expense ratio. But if it costs you $20 or $25 to trade it, you are actually charging more fees to the client than you need to be. And in terms of proper share class selection, what regulators care about is all in costs, including the transaction charged to the client, what is the fee actually being charged?
On the ETF side, you’re looking not only at net expense ratio, but also the spreads. Is it trading to a premium to its net asset value? Is the ETF doing securities lending, which is credited back to the client who owns the ETF? All these things impact total fees to the client and need to be taken into consideration because fees do directly reduce your performance.
The other thing I think is really important to look at in addition to who’s managing the fund and what’s the performance? What are the risk adjusted returns? You need to have a really good sense of the style of the strategy. When is this type of strategy going to go out of sync with the markets? You know, as I mentioned earlier, every strategy will struggle at some point in time. Momentum strategies will struggle during sideways markets, dividend-oriented strategies can struggle whenever high-risk type securities are what’s rallying. Index investing outperforms when large cap beats small cap and domestic beats international, but active management outperforms when the reverse is true. And so, there’s always going to be market environments where whatever you’re investing in is very likely to lag. And so, by really understanding the manager going into it and understanding when they might lag, you can be proactive with your portfolios and adjust the portfolios accordingly ahead of time in order to really help improve the risk adjusted returns for your clients. So, I’d say it’s a really comprehensive review, well beyond how it screens taking into consideration sector tilt, you know, everything is going to impact this fund, this investment over a full market cycle for your client.
Cassie:
Yeah. I’d like to do another video in the future where we talk a little bit more about the costs like you were talking about ETFs and, you know, you might just make an assumption an ETF is always cheaper.
Hillary:
And it’s not always, sometimes it’s more expensive than a mutual fund. Once you’ve taken into consideration all the costs.
Cassie:
Yeah. I think that’s another good topic for us to talk about in the future too. So, talk to me about advisors who may be building their own portfolios and then they have kind of a set it and forget it approach and they might not be trading frequently at all.
Hillary:
Okay. Well, that’s a concern of regulators lately. You know, over the last few years, there’s been this huge shift in our industry away from commission-based business and toward fee-based business. Because as a fee-based investment advisor, it does tend to align your interests as the advisor with that of your client, so there is more focus these days on something called reverse churning. And I’m not sure if you’ve ever heard of that Cassie, but one, if, let me back up and say it this way, if churning, which most people are familiar with is really in the commission-based business an advisor recommending a lot of transactions for their clients just to earn a commission to feed their wallet. Reverse churning is the opposite. So reverse churning occurs whenever you’re charging an investment advisory fee to a client, but you’re not actually managing the portfolio in order to earn that fee over time.
And that’s something that the SEC and FINRA has really been focusing on over last year. You know, if you’re charging, you know, one, one and half percent all in to your client and the SEC comes in and they see that, wow, you bought some mutual funds or some ETFs two years ago, and the account hasn’t been traded since what documentation do you have to show that the account didn’t need to be traded, or that you’re actually managing the account that you are actually earning that fee. And the SEC has fined some firms for that for charging a flat advisor fee on account, and then not actually managing it. And so, you need to be really careful whenever you’re building these portfolios to not set it and forget it. You need to be adding value to your client and documenting in your procedures, in your process, maybe why you didn’t trade the accounts. You just need to have a process that you can show to regulators as to what you did and why you took that step.
Cassie:
Well, I had heard of it, but I think it’s back when I took my Series 7, and then I really hear about it again, and then as we are working on our portfolios, it’s something that we are aware of and making sure we’re focused on avoiding any challenges around that. Hillary, can you just talk a little bit about how often are you reviewing mutual funds and ETFs for our portfolios? How often do you do that?
Hillary:
Sure. Well, I do a review at least quarterly on all the mutual funds and ETFs in our models. So shortly after quarter end, I start getting in all the attribution from our funds. And I really look through all the attribution analysis to make sure that the funds are performing in line with expectations. And then if there are any red flags, I’ll do a deeper dive into the strategy. So quarterly, I’m looking at everything on a higher level, and then at least annually, I’m doing a full review of every strategy that we hold in our portfolios.
Cassie:
And I always love it when you say, “I love to read prospectuses.”
Hillary:
I just three of them yesterday, they’re a good read for an analyst like me.
Cassie:
I don’t love to read prospectuses but I’m that Hillary does. I get the benefit of her wisdom. So, Hillary we’ve about a lot of aspects of being a good fiduciary today. Is there anything else you would say to independent advisors who are trying to do this themselves? What advice would you leave them with or anything else you want them to be thinking about?
Hillary:
Yeah, I would just say, you know, it’s, it’s a lot of work to take on this type of fiduciary responsibility. Not only do you have to do all the screening, but also manage the portfolios in a very prudent way in order to really bring a level of excellence to your clients. You know, the Bible instructs us to try to be excellent in all that we do and at LightPoint™ Portfolios, that’s what we’re trying to do for our clients. And that’s the level of service we provide to advisors who use us as well. So, I would just encourage you to dig in, see what’s out there, and do your best.
Cassie:
Great. Thank you, Hillary for that. And if you have questions about how you’re managing your portfolios or anything else related to BRI or faith based investing, please email me at cassandra@beaconwealth.com, and we’ll be sure to address your question on one of our videos about infrequently asked questions.