Does Adherence to the Practices Really Make a Difference?

I was teaching an AIF classroom program in San Diego last month and one student asked during a break:  "how can I convince prospective clients that these Practices really make a difference; most of them just don't get it."  His underlying message was that the focus is always on performance and that any discussion beyond that is either misunderstood, disregarded, or ignored. 

I proceeded to give my standard answer as I get this question somewhat regularly.  This standard answer typically touches on the following basic points:

• The fiduciary standard is a process, not performance, standard, so if someone complains and you end up in litigation or arbitration, it is your process that will be scrutinized.  Admittedly, part of that process includes monitoring performance.
• Following the Practices, which we often refer to as a defined checklist, helps to ensure that something does not fall through the cracks.  Most fiduciary breaches result from errors of omission, rather than commission; most are trying to do the right thing.
• As your process improves, better performance will follow.  For example, using established, objective criteria to select the investments and service providers; formalizing an investment policy statement to guide all investment management decisions; and controlling and accounting for investment expenses, will all drive better performance.

The last point is usually where I hear (and this time was no different):  "do you have any data to support the notion that better process means better performance?"  In the past my answer has been no ("we firmly believe it is true, but can't prove it"), but a recent study does provide some ammunition; finally!

Practice 1.4 of our Prudent Practices for Investment Advisors handbook says "Fiduciaries and parties in interest are not involved in self-dealing."  That means you avoid conflicts of interests whenever possible, or you disclose and get informed consent to any conflict that remains.  In 2005, the SEC conducted a study of pension consultants and found that the majority of those consultants had conflicts that were not adequately disclosed.  A recent GAO follow-up study titled "Private Pensions - Conflicts of Interest Can Affect Defined Benefit and Defined Contribution Plans" and published on March 24, 2009, points to a statistically significant 1.2 to 1.3 percent performance differential between defined benefit (DB) plans where the pension consultants adequately disclosed their conflicts of interest and those that did not.  Those plans that were better informed regarding conflicts of interest had higher investment returns.  The study focused on DB plans, but argued that the results could be applied to defined contribution (DC) plans as well.  Although the GAO Report clearly points out that this study alone is not "necessarily evidence of a causal relationship," and the study only relates to one of the fiduciary practices, it is data that supports our firm belief that incorporating the Practices will result in a better process, which drives better performance.

Comments

[Blane Warrene]

This is a great piece and right on point. Process - a conversation a lot of folks do not like to have because it hits close to home with staff and habits - is critical. As you note - it is always the process that is scrutinized no matter what.