In my last column, I discussed several areas of potential impact of the new DOL rules to registered investment advisers. Although not intended as an all-inclusive list nor one that applies to all RIAs, I broke down the possibly affected advisory tasks into three categories:
• Pre-Investing: Risk tolerance assessment, designing and recommending an asset allocation, coordinating investment goals with financial planning and creating an investment policy statement.
• Investing: Selecting funds, ETFs, stocks, bonds and/or other investment vehicles for clients' portfolios; determining an appropriate management strategy considering rebalancing parameters, cash needs and tax implications; selecting a custodian (or custodians) based on clients' needs and preferences as well as best execution; implementing an effective and coherent portfolio monitoring and reporting system; utilizing a timely methodology for monitoring and evaluating funds' (and other holdings) performance and management on an ongoing basis.
• Advice: Recommending an implementation strategy on 401(k) accounts (such as choosing between a target date fund, pre-selected asset allocation or hands-on management), advising on rolling qualified plan assets into an IRA, suggesting Roth conversion (or reversal) and developing a draw-down plan in retirement.
To assist in implementing and documenting DOL fiduciary compliance, advisers should consider utilizing several of a range of applicable tools and technology.
In the pre-investing category, it's all about getting to know the clients — their goals, risk tolerance, current assets and liabilities, tax situation, etc. Some of this knowledge is factual, such as investment statements, tax returns and mortgage balances. Other pieces are soft, which require meetings, evaluation and analysis. In all aspects of pre-investing services, the adviser is faced with integrating the factual with the non-factual. The following tools can be helpful — or even imperative — during this phase:
• Risk-tolerance assessment: To document the appropriateness of a particular asset allocation, some type of standardized approach is necessary. Suggested offerings include those from Finametrica, Riskalyze and Morningstar (Ibbotson). Advisers should note that these are quantitative tools that attempt to interpret qualitative data. Thus, conversations citing real-life examples are necessary to truly assess any client's true ability to tolerate risk.
• Asset allocation modeling: As opposed to arbitrarily selecting asset classes and percentages for asset-allocation models, due professional care requires analysis and documentation. Advisers have the options of outsourcing this analysis or utilizing software to derive efficient portfolio models. Available tools include those from Morningstar (Ibbotson), Advisory World, Zephyr and SunGard.
• Financial planning: To truly coordinate investment strategy with individual goals, at least some degree of financial planning is a must. Depending on the adviser's/clients' needs, software choices can be basic or complex, goals-based or cash flow-based, modular or comprehensive, interactive modeling or formal report output, and integrated with other advisory software or stand-alone. There are numerous financial planning programs available to advisers. The most commonly used are MoneyGuidePro, eMoney and Naviplan.
• Proposal generation: Demonstrating and documenting a fiduciary engagement relationship requires attention to both objective and subjective details. Client deliverables include a formal proposal summarizing services and value-added benefits, summation of fees and expenses, engagement letter, and investment policy statement. Proposal generation tools are offered by several custodians as well as ASI, Orion and providers of asset allocation software including Morningstar, Advisory World, Zephyr and SunGard. Investment policy statements can be customized with templates from an adviser's compliance consultant or attorney, accessed directly from a turnkey provider (BAM, SEI, Morningstar), or automated with IPS Advisor Pro.
The investing phase involves all functions related to choosing investments, managing and monitoring the portfolio, reporting and choosing custodians. To thoroughly analyze and document compliance with fiduciary requirements, advisers might want to consider individual tools. Alternatively, outsourcing to a turnkey solution can take the headaches out of complying with the new requirements. TAMP options include BAM, SEI and Morningstar's indexes or managed portfolios. Individual tools for the various tasks include:
• Portfolio accounting and reporting: Portfolio accounting software is offered by PortfolioCenter, Morningstar Office, Orion, Black Diamond, Advent, Finfolio and others.
• Rebalancing software: Rebalancing software ranges from basic rebalancing options through custodians to more sophisticated tax-efficient software such as Morningstar's Total Rebalance Expert, Red Black, Blaze or iRebal.
• Data aggregation: To consider and incorporate all of a clients' assets, data aggregation can help ensure that investments are specific to each client's total investment universe. Depending on the depth of data required, suggestions include ByAllAccounts, Wealth Access or Blue Leaf.
• Investment analysis: In terms of investment analysis (fund ratings and data, analytics and screening capability), Morningstar is the industry leader. Another useful tool in fiduciary screening is offered by fi360.
Although more nebulous that the prior two categories, advice services must be documented as meeting industry standards and in the best interests of clients. Thus, advising on 401(k)s, 529 plans, Roth conversions, retirement draw-down strategies, etc. requires confirmation from outside channels rather than merely the adviser's internal evaluation. Many of the tools listed above are relevant in the advice category. Additional resources can include retirement plan and 529 plan analyses by Morningstar or other providers, tax projection software from BNA or LaCerte, and tax research tools from Thompson Reuters or other providers. The bottom line is that any advice provided to a client must have some type of written support to document the best interests requirement.
Waiting until the effective date to implement compliance methodology is too late. Now is the time to inventory your services, standardize your processes and determine how best to approach compliance and documentation for each task category.