Does Your Investment Manager Have Your Best Interests in Mind?

[Vince DeCrow]

After taking office, the Trump administration reversed a regulatory effort that put a spotlight on the fees that investment advisors received for managing retirement accounts, which forced the Department of Labor (DOL) to put its “fiduciary rule” on hold. The fiduciary rule is the concept that professionals who manage money should work in their client’s best interest, regardless of fee arrangements.

The term “investment fiduciary” is broad, referring to anyone who has the legal responsibility for managing somebody else’s money. They can be financial advisors, bankers, investment managers, accountants…etc. Fiduciaries are legally and ethically bound to act in their client’s best interests.

This rule is important for anyone paying someone else to invest their money on their own behalf, and especially important for high net worth investors. The person who you entrust with your money should be committed to putting you in investments that meet your investment goals. While the pending fiduciary rule is meant to hold fiduciaries to this standard, alignment of interests is necessary for every investor and successful investment.

Unfortunately, many investment professionals today are not fiduciaries and are only held to the “suitability” standard, which could negatively affect the returns of high net worth investors. This means that they can legally recommend investments that generate the highest commissions for them, as long as it’s suitable for you, the client, but not necessarily in your best interest. For example, advisors at companies such as Goldman Sachs and JPMorgan sell many of their own commission-driven products because they are incentivized to do so. Some of the most efficient investment products in the market today, such as Vanguard Funds, don’t pay any commissions to sell their products. If operating under a broker, investors may miss out on these types of these opportunities since the broker would not be incentivized to put their client in that investment.

A fairly recent Financial Industry Regulatory Authority (FINRA) investor alert pointed out the importance of investors giving careful review to public and private real estate funds in particular, as these managers are not legally obligated to do what is in an investor’s best interest. As an investor relations employee of a private real estate fund, I’ve spent a significant amount of time talking to our high net worth investors who have taken this message very seriously and are interested in how real estate fund fees affect their returns. For this reason, we tell high net worth and accredited investors to look for the three defining features to determine if someone managing their money has their best interests in mind:

1. Skin in the Game: Investment managers should stand to gain only if their investors are also successful. The best alignment of interests exists when managers invest in the same products they sell to investors, or when their personal payout depends on performance of the investments they are recommending.

2. Commissions: Beware of real estate products that are sold. Non-traded REITs pay advisors large commissions to sell their products and can have a front end load as high as 18%, meaning that in those cases only 82 cents of every dollar is put to work for the investor. I would not personally make an investment knowing that I am at a 18% loss on day one.

3. Strong risk management controls: A disciplined investment team has controls in place to minimize risk. Some examples of real estate risk management would be:

• Using debt responsibly by not over-borrowing or putting up multiple properties as collateral for a single loan
• Conservative and defensible investment underwriting assumptions
• Well-defined investment strategies that are transparent to investors and able to be continually monitored through investor reporting

Changes in the regulatory landscape make it clear that investors must be proactive when vetting potential real estate investments. A firm understanding of wealth-building goals and a willingness to screen investment managers using the three points made above can help when choosing investment professionals who are best aligned with your goals and will work to your benefit.