Independence, Interdependence and Your Investment Portfolio

By Alton Cogert | acogert@saai.com

Later this week, we in the US will be celebrating our 243rd year of independence from the British Empire. And, although some may call this national holiday, ‘July 4th’ or ‘The Fourth of July’, its correct name is “Independence Day.”

Independence has long been a celebrated characteristic in this country.

Yet, ironically, we live a very interdependent existence.

Where the new citizens of a new country in the former thirteen colonies relied much more on their own resources and abilities, today we are a country of specialists deeply dependent upon one another.

Need some food? Few of us eat only what we harvest. Most all of us roll up to our local grocery stores, choosing from what that specialist has available.

Feeling sick? No need to use home remedies (please, no tying string between your tooth and a door knob). Much better remedies are available to us from pharmacies, doctors and our largely inefficient, but specialized, health care system.

We are a country of interdependence formed on Independence Day.

Your insurer or government risk pool is undoubtedly filled with specialists. People that know about your insureds, the risks being taken and what an adequate compensation for those risks might be.

However, your insurer or government risk pool is also likely to be dependent on others when it comes to specialties outside of your own. You may be dependent on the ‘IT guy’ when your computer goes on the blink.

And, you may be dependent on your external investment manager to make certain that investment income and returns are adequate for your business.

In practically every case where we are dependent on others, personally or in business, we want those others to provide excellent, independent service at a fair price that is fully disclosed, and not subject to deleterious conflicts of interest.

We are a country formed on Independence Day, consisting of interdependence with those from whom we require independence.

Perhaps that seems a bit ironic or confusing, but it gets even more so when considering the investment advisors to your insurer or government risk pool.

Different names for different types of advisors.

William Shakespeare tell us, “a rose by any other name would smell as sweet.”

But, what happens when that rose’s thorns come to the fore and “something is rotten in the state of Denmark?”

What is a financial advisor? What does that title mean and how does it differ from financial consultant, investment consultant, investment manager or any number of creative titles that are out there?

More importantly, how does that individual or his firm get compensated for all that he might do for you? And, are they getting paid in different manners from other entities that may not have your best interests in mind.

Of course, ‘Best Interests’ is what is behind the SEC’s latest pronouncement, Regulation BI which requires broker-dealers to act that way towards their clients…by next year.

Viewing Regulation BI, the US House of Representatives has already moved to block funding for its implementation. So, next year’s time frame could easily sink into the sunset.

Meanwhile, with or without the SEC, the very important question seems like a simple one, with a likely very complex answer:

How does the ‘financial’ person, no matter the title, and her firm get directly and indirectly paid, and wherein are all the possible direct and indirect conflicts of interest?

Is the advisor a ‘fiduciary’?

Generally speaking, if you are working with a ‘registered investment advisor’ (registered with the SEC), they are subject to acting as a fiduciary.

A fiduciary must always act in the best interests of her client.

But, multiple potential conflicts of interest can make this a difficult balancing act. So, we are back to asking those direct and indirect fee, as well as conflict of interest questions.

Biased recommendations.

Some of the nicest individuals you will ever meet may recommend a given asset allocation or investment type, but they are still subject to the embedded conflicts of their firms’ business models.

For example, we have seen some core fixed income managers of insurer assets provide some excellent advice. However, their firm’s business models might be, ‘we realize managing insurer core fixed income portfolios is a competitive, relatively low fee operation. But, we can make it worthwhile by recommending some rather captivating, yet much higher fee, alternatives.’

One wonders if the recommendation would be the same coming from another investment manager or an independent investment consultant that exhibits greater transparency and lesser conflicts of interest.

With our interdependence comes an obligation to ask for transparency from those with whom we require independence. It may be time to ask some difficult questions.

Happy Independence Day!