Philanthropy Is the Lifeblood of Family Continuity

"Because philanthropy causes people to think of something bigger than themselves, it can be one of the most powerful forces for keeping a family together. If your client's goal is to keep her family members together across the generations, this may be the best way of achieving it" . Click here to read more.

Source: Wealth

Avoid Emotional Investment Decisions

Authors: Chris Meyer, Innovest Vice President and Abigail Thomas, Innovest Lead Senior Analyst

Imagine waking up on Saturday morning in early April of 2016, ready for a sip of coffee and a quick look at how your investments performed during the previous quarter. Your eyes land on Harbor Capital Appreciation, your large cap growth fund. The performance numbers catch your attention, but not in a good way. The fund was down 5.49% in the first quarter, while the benchmark, the S&P 500 Growth Index, was up 0.53%. Instead of essentially breaking even with a low-cost index fund, you paid active management fees and lost about 5.5%, in one quarter? Harbor Capital Appreciation seemed like a poor investment. Surely you could have been invested in something better. You decide that you are going to call your advisor and discuss replacement options.

Why Do I Think This Way?

You pause long enough to eat breakfast before making the call, which allows your emotion to subside a bit. Reflecting for a moment, you ask yourself: Why the immediate, emotional reaction to last quarter’s poor performance? Because you are human. Our decisions are often influenced by the subconscious biases that swirl around beneath our conscious reason. Some of those cognitive biases can help explain why it is so easy to make a snap judgment when confronted with an investment loss.

Paying Too Much Attention to Recent Pain

People tend to experience the emotional pain of negative events, including investment losses, twice as strongly as they experience positive emotions from good events, like investment gains. To state the principle conversely, a positive experience creates about half the amount of emotional impact as a negative one. Paired with human tendency to allow emotions to influence decisions, it’s a recipe for less-than-rational decisions.

These tendencies are a central feature of Kahneman and Tversky’s 1979 prospect theory, which argues that people derive utility, or satisfaction, from changes in wealth, rather than from absolute levels. A simple example illustrates the concept: A person given the choice between 1) receiving $20 and 2) receiving $40 then immediately losing $20, will typically choose the former. That is true even though each situation results in the person having $20; the loss involved in situation two makes it much less appealing.

Another obstacle to investing rationally stems from the human tendency to give more weight to events that occurred recently as compared to events in the more distant past. Despite many past quarters outperforming most large cap growth managers, Harbor Capital Appreciation’s recent performance had been poor, which could have resulted in our human brains judging the investment as an overall poor performer.

These recent, painful experiences are sometimes distracting from other highly relevant data points. Here, investors may have trouble seeing past recent poor performance despite understanding that performance is only one of many factors that should bear on selecting a mutual fund. After all, investors ought to give great weight to qualitative measures of investment process, style, and personnel, along with the fund’s historical performance.

What Happens if I Act on These Tendencies?

Typically, reacting to recent underperformance is a recipe for mediocre investment results. A 2008 study examined the behaviors of 3,400 retirement plan sponsors between 1994 and 2003, specifically focusing on 8,755 manager hiring decisions1. The study showed that fired managers tended to outperform their replacements during the three years after the change, even when their historical returns outpaced the fired manager over the previous three years.

What Should I Focus on Instead?

First, remember every fund will underperform for periods of time. The reasons can vary from market cycle, to the fund’s investment decisions taking time to play out, to the manager’s unique style simply being out of favor. Diversification—investing in several different asset classes— typically results in a mix of investments outperforming and underperforming in all market environments. This fund diversification normally lowers the portfolio’s volatility, reducing the shock that any one market factor can have on the portfolio.

Second, consider both quantitative and qualitative measures when monitoring an investment. At Innovest, we pay close attention to the fund’s investment style and strategy, the manager’s experience and credentials, and the overall organization structure and governance. When we score an investment highly in these categories, it means that we have conviction that the necessary pieces are in place for the investment manager to execute a thoughtful and proven strategy that will achieve the fund’s stated goals. Paired with the quantitative measures of the fund’s size, performance, and costs, these qualitative criteria provide a robust picture of an investment and its suitability for your portfolio.

So, when should performance be an issue? When the underperformance is inconsistent with the investment manager’s process or style, or is the result of a significant process or personnel change, an investor should closely examine the merits of changing managers.

Returning to our Harbor Capital Appreciation example, the underperformance relative to the index experienced in the first half of 2016 was not inconsistent with the established investment process, was not the result of a change to fund management and was not a problem warranting manager replacement. Changing funds would have been a mistake.

In fact, if you avoided the pitfalls described above and remained invested, you would have been rewarded with a total return of 22.77%, 2.27% in excess of the S&P 500 Growth Index return of 20.50%, for the period April 2016 through June 2017. Qualitatively, the same investment team has continued to employ the same investment strategy. This includes a willingness to significantly overweight sectors that the team expects to outperform.

To be clear, this example does not prove that every underperforming fund will have an incredible upswing in the following year. Nonetheless, we believe focusing on short-term performance can distract investors from more meaningful factors and lead to suboptimal investment decisions.

1 Goyal, Amit, and Sunial Wahal. “The Selection and Termination of Investment Management Firms by Plan Sponsors.” THE JOURNAL OF FINANCE, LXIII, no. 4, Aug. 2008, pp. 1805–1847.

Source: Innovest

Leadership with Heart

Innovest CEO Richard Todd was recently a guest on the Leadership with Heart Podcast. In this episode, Rich shares his views and his experience on empowering others, continuous improvement as a leader, servant leadership and viewing roles as a vocation instead of a career.

"The best way to get somebody's attention and lead them, is to serve them." - Rich Todd

Click here to listen to the podcast.

Source: Leadership with Heart

11 Tips to Reduce Litigation Risk

11 Tips to Reduce Litigation Risk

Gordon Tewell, CFA, CPC, ERPA | Principal, Innovest Portfolio Solutions

While retirement plans with billions of dollars dominate the plan litigation headlines, smaller plans have the opportunity to learn from the suits filed against their larger plan peers and hopefully avoid possible litigation.  

Until recently, the fee-based claims against retirement plan fiduciaries targeted “mega-plans” – e.g., Verizon ($30B); Chevron ($19B); Intel ($15B); Oracle ($11B); American Airlines ($9B) – but two cases may indicate an extension of fee based claims into the small/mid-size plan market: CheckSmart ($25M) and LaMettry’s Collision ($9M).

There is no doubt that litigators have been busy. We are seeing new approaches to court cases -whether an attack on revenue sharing, continued focus on company stock, or new inquiries into stable value, fee structures, or custom target-date funds (TDFs)—litigation doesn’t show signs of letting up. The suits attack plan sponsors, recordkeepers and, in some cases, investment managers. Recent cases bring a number of new attorney names into the litigation world as new entrants in the plaintiff attorney world continues to grow. The pace is unlikely to slow as cases are quickly duplicated.

Unfortunately, we are in a world where every action can be put under the microscope.

Committees should feel confident that, if they follow fiduciary best practices and due diligence, they have a strong defense. A prudent process and documentation is more essential than ever. There’s no time like the present to make sure you and your investment committee have a strong fiduciary file and continue to try to raise the bar.

While the fees, penalties and settlements of the cases mentioned above amount to huge sums, the actions that prompted these lawsuits are not unique to the handful of companies being charged.  Plan sponsors should be taking copious notes and learning lessons from this litigation.  Since it’s hard to predict what’s going to happen in the courts, plan sponsors should look to reduce the risk of litigation by following a best-practices strategy. Some key steps that sponsors can take to improve the plan for participants and protect themselves as fiduciaries include:

  1. Keep your ear to the ground. Know what is going on within the industry and what a prudent person would do.
  2. Benchmark and evaluate your providers. Even if a plan is satisfied with its current provider, consider periodically benchmarking or going out to bid with a Request for Proposal (RFP). The RFP process may disclose administrative and cost saving opportunities. Ensure that provider fees and expenses are reasonable by evaluating competitive bids every few years. An RFP process may uncover whether you are overpaying for services and whether other competitors might be providing useful additional services that your current provider does not offer.  At the end of the exercise you may not be dissatisfied with your current provider, but at the least, you will know whether you should be renegotiating your current provider’s fees.
  3. Offer a broad mix of investment options.  This will allow participants to adequately diversify their accounts. The menu should include low-cost index funds. Ask yourself, “Is a competitive capital preservation investment option available, and has the investment been thoroughly vetted?”
  4. Engage in fiduciary training. It is imperative that all committees understand the legal responsibilities of their position as a fiduciary.
  5. Review the cost and structure of your investments. A committee (or other fiduciary) should document that it regularly investigates share classes and fee options to ensure that it has considered the lowest cost option for which it qualifies. If higher cost funds are selected, a committee (or other fiduciary) should document the process that led to the selection of a higher cost fund as opposed to a cheaper fund - e.g., documenting the relative performance of the higher cost funds net of fees. Ensure fee transparency and equality for employees.
  6. Follow your governing documents.  Plans should adopt an Investment Policy Statement and follow it. Adopting a policy and not following it can be worse than not having a written policy at all.  Modify or update the policy as appropriate.
  7. Watch the proprietary funds.  Recent litigation has focused on providers who put their own funds in their employee plans even though they were not top performers. Ensure that you evaluate all investments options, using an unbiased, well-documented process that can reliably evaluate how well each option is aligned to your plan’s needs and demonstrate the prudence of your decisions.
  8. Hire expertise.  Unless you are a very large business with employees who have real expertise and time to spend, you are courting disaster by trying to do everything in house. Just about every plan needs professionals advising about investments and fees.  And those professionals should acknowledge that they are fiduciaries.
  9. Monitor your revenue arrangements.  There are alternatives to paying for plan services through revenue sharing that are more transparent. If you do enter into a revenue sharing arrangement, make sure your provider isnot being overpaid or that revenue sharing is not being used to pay for services to the plan sponsor rather than the plan participants.
  10. Continue to monitor the Plan investments.  Just because you picked an appropriate menu years ago does not mean your menu is the best for participants today.  Fiduciaries need to monitor performance against benchmarks and to be aware of new funds and alternatives to regular mutual funds, such as separate accounts and collective investment funds. 
  11. Hold regular committee meetings.  Prepare agendas and keep written minutes to record what is discussed and the reasons for decisions. Careful documentation makes it much easier to show a court that you were acting prudently. Make sure your notes are thorough.

One of the most dangerous statements that can be made is, “We have always done it this way.”  Plan sponsors now have a unique opportunity to learn valuable lessons from these lawsuits and court cases and adopt best practices for managing their fiduciary processes and responsibilities. 

Source: Innovest Portfolio Solutions, Gordon Tewell, CFA, CPC, ERPA




Research Your Interests

How do you solve problems you care about? You do research. See how the research Excellence in Giving does helps identify nonprofits with real solutions. Click here to read more .

Source: Excellence in Giving

Balancing the Positives

In his latest commentary, Blackstone’s Byron Wien opines on stocks, interest rates, politics, the central banks, inflation, regulation, as well as what he believes investors are too focused on, and what they are paying insufficient attention to. Click here for “Balancing the Positives”.

Source: Blackstone

Brightscope and ICI Release Latest Edition of Comprehensive 401(k) Study

“One of the strengths of the 401(k) system is that it allows employers to customize their plans to meet the needs of their unique workforces,” said Sarah Holden, ICI’s senior director of retirement and investor research. “Employers use that flexibility to offer features that can encourage participation. Employer contributions, auto-enrollment, loans, and diverse investment options—including target-date funds—can make it easier for 401(k) participants to plan and save.” Click here to read more.

Source: BrightScope