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Discretionary vs. Directed Investment Risk

Discretionary vs. Directed Investment Risk. By: Melody Bohlmann IM&T Investment Risk Manager Wells Fargo Wealth Management Group. Key Risks. Operational Risk Market Risk Business Risk. Operational Risks. You have them whether you have discretion or allow for direction

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Discretionary vs. Directed Investment Risk

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  1. Discretionary vs. Directed Investment Risk By: Melody Bohlmann IM&T Investment Risk Manager Wells Fargo Wealth Management Group

  2. Key Risks • Operational Risk • Market Risk • Business Risk

  3. Operational Risks • You have them whether you have discretion or allow for direction Example: IM/Asst. input trade incorrectly – wrong asset – incorrect ticker, wrong amount - shares, units, dollars • What is different is disputes – internal vs. external

  4. Operational Risks Ways to mitigate internal vs. external risk: • Require direction via: • Recorded phone lines • Issues: expense research • Written direction only • Fax • Email • After the fact confirmation • Issues: Timing Follow-up monitoring Can be addressed with appropriate language in governing instrument and disclosures

  5. Operational Risks continued You also have the following operational risks: • Asset set up • Dividend/Income processing • Pricing/valuation The difference is that when you are purchasing discretionary assets you generally have a controlled process for ensuring that they happen correctly

  6. Operational Risks continued Soft dollars – Section 28(e) safe harbor - only commissions from discretionary trades can be used for research or services

  7. Market Risk • Market movements - timing difference between time of direction and execution • Errors – do you make client whole, how do you make client whole • Gains vs. losses • Tax effects • Performance differentials • Long-term difference between value of asset directed and what could have been • Do you have an obligation to monitor the asset? • How are they monitored

  8. Issues To Address When Deciding on an Individual Account Level • Authority • Purpose • Type of Account • Investment Objective • Asset allocation • Diversification • Risk Mitigation

  9. Business Risk • Firm decision vs. individual client and individual asset decision • What does the competition do • Will a decision not to allow for direction cause the business line to lose business to the competition • What does it cost firm to allow direction and put in proper controls and monitoring Reputation, Operational, Investment risks: if we do, if we do but don’t do it properly or monitor properly, or if we don’t – same questions should be asked on individual account and individual asset level

  10. Authority What does the governing document say? • Sole • Shared • Allow for direction

  11. Purpose Purpose of the Account Purpose of the proposed investment

  12. Type of Account • Agency • Revocable • Irrevocable

  13. Uniform Prudent Investor Act §2 (b) “A Trustee’s investment and management decisions respecting individual assets must be evaluated not in isolation but in the context of the trust portfolio as a whole and as part of an overall investment strategy having risk and return objectives reasonably suited to the trust.”

  14. §184 & 185 Restatement of Trusts, Second & §9 Uniform Prudent Investor Act • Scope of duty under trust or agency agreements • Expectations of the parties reflected in the compensation paid for the duties undertaken • Reasonable expectation of the bene/principal based on the representations and conduct of the institution • General duty of directed trustee to reject directions or seek instruction where the direction facially constitutes a breach of trust - which violate either the terms of the agreement or general fiduciary principles

  15. Investment Objective & Asset Allocation • How does the investment proposed fit with the investment objective of the account • Does it take into account income, principal and/or remainder bene’s • Is the asset a type that is one of your firm’s asset allocation types • Will a re-allocation be needed if the asset is accepted

  16. Asset Set Up/Pricing/Valuation • Do you have the appropriate types of asset codes to ensure that the asset is set up properly and can be monitored • Will the pricing feeds automatically price the asset or will manual pricing be necessary, if manual necessary what will the pricing be based on and how often updated? • Will the valuation meet regulatory/legal requirements

  17. Diversification • Generally required • What is your policy • Will the acceptance of the asset cause a concentrated position, concentrated asset type, sector, industry

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