Investment managers say transparency key to client relationships

It's a lot of money.

Small- to medium-sized companies, not-for-profit organizations, municipalities, counties and pension funds can have portfolios that range anywhere up to the billions of dollars.

For guidance on investing those large sums, they turn to financial managers with experience in such large portfolios.

But whether they are selected in response to a request for proposal or by referral, investment managers believe they must be transparent regarding how they plan to manage a client's investment portfolio.

Investment policy statements, which lay out how investments will be selected, are not required by state or federal law. But Eastern Iowa investment managers believe they are crucial to a successful relationship.

“We feel very strongly that the investment policy statement is a critical tool in the process,” said Brian Rolland, senior managing director of BTC Capital Investment in Cedar Rapids. “We're the type of investment manager that takes investment discretion over the portfolio, so we like to prepare a play book that tells us how to operate from an investment perspective.

“It's not always generated by us. Many institutions have an existing investment policy statement, which we typically will review and see if what they're trying to do is consistent with that statement.”

Barbara McKenzie, executive director, chief operating officer & boutique operations at Principal Global Investors in Des Moines, said investment managers in the United States are required to maintain a disclosure statement with the SEC known as a Form ADV.

"A portion of that form must be provided to existing clients of the firm each year," McKenzie said. "It is the main disclosure statement for U.S.-based managers and discloses key elements such as fees, conflicts of interest, key personnel, etc.  The Form ADV is the main format for disclosure used in our industry." 

After Principal Global Investors is hired by a client, McKenzie said it enters into an “Investment Management Agreement” with them, and there is typically an addendum to that that is the “Investment Guidelines.”

"The guidelines serve as a reference point between the client and the manager and set out critical elements for the management of the portfolio, such as a benchmark against which the manager's performance will be evaluated and restrictions on what the client can do within the portfolio," she said. "These restrictions are monitored by most investment managers pre- and post-trade to ensure compliance when the security enters the portfolio, and over time as market prices move."

Tim Terry, founder of World Trend Financial and Terry Lockridge & Dunn in Cedar Rapids and Iowa City, said clients occasionally will set very narrow investing parameters that “handcuff” investment managers.

“A lot of times requests for proposal will define the asset allocation model and ask the parties being solicited ‘Will you manage my money this way?' without regard to the most effective way to manage money,” Terry said.

“I've sat on both sides of the situation as a member of an institution's board of directors. I have taken great exception to that approach, saying I would rather see what investment managers show in terms of creativity before I make a decision.

“A good manager is going to walk into the room and say, ‘This is kind of what I do for a living. I'm going to discuss how we manage risk. I'm going to explain how we achieve the most intelligent rate of return.'

“If you're going to tie his hands by saying he has to have a specific asset mix or that certain assets are out of bounds, he is likely to withdraw from consideration.”

On the other hand, investment policy statements sometimes can be too broad, according to Rolland.

“One of the recommendations that we make is to narrow it down,” he said. “There's just too much flexibility and you create potential situations where an investment manager can add inherent risk to the portfolio for the sake of performance.

“That's not to tighten to investment parameters to the point where we're handcuffed. We think it should be a ‘loose set of handcuffs' that allows the investment manager to effectively manage the portfolio - but not so broad that they can go outside the parameters and get the portfolio in trouble.”

Personal referrals, rather than RFPs, often play a major role in deciding which firms manage institutional portfolios in communities the size of Cedar Rapids and Iowa City, said Jon Werner, managing principal with Stonefield Investment Advisory in Cedar Rapids.

“People in communities like Cedar Rapids want to do business with people they know and can trust,” Werner said.

Werner said investment advisers serving on the boards at not-for-profit organizations can find themselves in an ethical dilemma when it comes time to select an investment manager.

“You don't want it to seem incestuous, so you're used for advice,” Werner said. “It hurts your guts because you love your work and you want to work with the organization, but you feel like you can't because it might be considered a conflict of interest.”

So, like Tim Terry, he advises as any board member would, no more or less.

There is a good reason for needing outside investment guidance.

Pension funds such as the Iowa Public Employees' Retirement System (IPERS) issue an RFP when they're seeking new investment management. With the volatility in equities, many institutional investors have become primarily focused on preserving principal rather than the interest earned on their investment.

“My No. 1 client came to me around 2000 and told me he had been beat up in the stock market,” Werner said. “He gave me what was left and told me that he didn't want to lose any of his principal.

“I had to take $1 million and work backward with CDs and other investments to assure that he wouldn't lose any of his principal.

“Using the 5 percent interest on a certificate of deposit, we were able to take some risks in the stock market. The market performed very well in 2002 and 2003, so we were off to the races.”

The selection of investment advisers has come under increased scrutiny is recent years as municipalities, state pension funds, not-for-profit organizations and other institutional investors have become victims of fraud or bad investments.

The IPERS has recovered more than $215.2 million or about 85 percent of its principal investment in Westridge Capital Management of Santa Barbara, Calif.

In 2009, the two principals of WG Trading Co. and Westridge Capital Management were indicted in federal court and charged with misappropriating institutional investor capital. One has pleaded guilty and awaits sentencing, and the other awaits trial.

Paul Greenwood and Stephen Walsh, former partners in WG Trading, were accused in what was described as “a brazen investment fraud” that misappropriated up to $554 million, from 1996 until their arrests in February 2009.

The IPERS had invested nearly $500 million with WG Trading and Westridge. Market losses in the 2008 slump had reduced the value of the investment to $291.2 million by the time of the firm's assets were frozen.

The city of Cedar Rapids invested $1.948 million in commercial paper, which provides money to businesses to meet their short-term, cash-flow needs. However, the investment in Golden Key Ltd., which was supposed to pay the city $2 million after several months, flopped.

The city sued Wells Fargo Brokerage Services in June 2008, claiming the brokerage violated federal securities law by selling “unregistered” investments that should not have been sold to government entities. The Cedar Rapids City Council eventually approved a settlement that repaid the city all but $250,000 of its original $1.948 million investment.

The settlement also paid the city $110,000 in attorney's fees and court costs.