Boards of Trustees of many state, provincial and local government pension plans have exercised their fiduciary responsibility to invest pension plan assets by retaining third-party investment managers1 and advisers2 (collectively referred to as professionals) to perform various portfolio services, ranging from advice-only consultation to fully discretionary management. As the use of investment professionals has become more commonplace, scrutiny of the relationship between investment professionals and public funds has increased.
GFOA has consistently recommended that governments exercise appropriate due diligence in their selection of investment professionals. This is particularly important because the investment committee has overall fiduciary responsibility for pension plan assets. GFOA recommends government pension plans develop investment professional selection policies, which address the following:
- Selection Method. The responsible public official or the governing board should appoint a pension investment consultant3 and/or review committee to conduct the search process. Training should be provided to the governing board so that they may determine appropriate qualifications for consultant or committee suitability. Responsibilities of the review committee and/or pension investment consultant should be stated as should be the method of selection. A competitive, merit-based procurement process should be employed. Responsibilities of the investment professional(s) should be clearly defined in writing.
- Sourcing Investment Professionals. The consultant and/or review committee should determine the sources for candidates to be considered based on procurement rules, including, but not limited to:
- consultants' database on investment management firms,
- industry reports and articles,
- marketing materials,
- references from other pension plans or jurisdictions,
- existing vendor database or registry, and
- other governmental entity resources and information.
- Ethics and Potential Conflicts of Interest. The pension board or administrative officer managing the investment professional procurement and contract should comply with the following ethical considerations:
- adherence to all jurisdiction's and pension board’s ethics laws, rules and regulations related to procurement and involvement with contractors, including those related to political contributions and procurement quiet period requirements,
- disclosure to pension board of any inherent or potential conflicts of interest in dealing with specific investment professionals prior to taking any official action, and
- adherence to the GFOA Code of Professional Ethics as well as other professional codes of ethics.
- Selection Criteria. The consultant and/or review committee should determine the criteria to be used in the evaluation and selection process resulting from the Request for Proposals. Criteria should consider local procurement rules and policies, such as vendor preferences, and in addition should include the following considerations:
- Organizational overview that includes:
- structure of the firm,
- number of years the firm has been in business,
- SEC or other authorizing registrations,
- education and experience level of key personnel in management of institutional assets as well as key staffing changes over at least three years, workforce diversity and turnover, compliance with applicable professional code of ethics,4 and
- potential conflicts of interest with the pension plan.
- Financial overview that includes:
- firm’s most recent financial statements,
- dollar amount of assets under management,
- dollar amount of other public pension assets under current management,
- dollar amount of the total assets in the specific style being considered,
- number of clients invested in the investment style, and
- past or pending litigation.
- Investment overview that includes:
- firm-specific investment philosophy and process, research, and portfolio management strategies,
- investment performance against various appropriate benchmarks,
- performance for the trailing 3-year, 5-year and 10-year periods for the firm,
- style parameters based on the portfolio, including the asset class and specialty focus, as appropriate, and
- confirmation that the firm is willing to act as an ERISA fiduciary as applicable with respect to the pension plan.
- Operational and compliance overview that includes:
- transition and implementation plan,
- system of risk management safeguards and investment policy compliance,
- back office, accounting, report and client service, disaster recovery plan, SOC 2 or other comparable compliance report,
- trading process and total trading costs, and
- management fees5, including favored nations pricing, if applicable, and any other costs or fees which may be charged to your agency.
- Final evaluation information that includes:
- references from other pension clients,
- a list of new clients gained over the prior three years,
- a list of clients lost over the prior three years,
- confirmation of availability for an on-site due diligence visit, as necessary and applicable, and
- commitment to deliver investment advisory SEC Form ADV Part I and Part II (including Schedule I) prior to contract execution.
- Organizational overview that includes:
- Contractual Considerations. After the consultant and/or review committee has made a recommendation regarding the selection of the pension plan investment professional, the investment management agreement should include the following:
- identification of account management personnel and their fiduciary responsibilities,
- certification that the investment professional will adhere to the investment policy,
- notification requirements, usually immediate, of any changes in firm ownership or key personnel,
- reporting requirements,
- determination of professional liability insurance for errors and omissions,
- establishment of fee and terms of invoicing and payment,
- specifications related to nondiscrimination in contracting and ethics rules,
- disclosure of any SEC violation or discipline,
- other third-party services agreements required by an investment consultant,
- educational services to committee,
- adherence to state/provincial law on fee transparency or industry standard, whichever is more stringent, and
- termination procedures of the contract by either party.
- Performance Monitoring. The pension board should develop and implement an ongoing risk control program, including ongoing compliance reviews such as:
- periodic, but at least annual, due diligence review of compliance with investment policy and investment performance,
- independent audits,
- compliance with investment guidelines, 6
- timely reconciliations, and other appropriate internal control measures.
1 Investment managers are defined as a fiduciary under section 3(21) of the Employee Retirement Income Security Act of 1974 (ERISA) and an investment manager section 3(38) ERISA. An investment manager is a person or organization that makes investments in portfolios of securities on behalf of clients, in accordance with the investment objectives and parameters defined by these clients. An investment manager may be responsible for all activities associated with the management of client portfolios, from buying and selling securities on a day-to-day basis to portfolio monitoring, settlement of transactions, performance measurement, and regulatory and client reporting.
2 An investment adviser is defined by the Investment Advisers Act of 1940 as any person or group who makes investment recommendations or conducts securities analysis in return for a fee, whether through direct management of client assets or via written publications. An investment adviser who has sufficient assets to be registered with the Securities and Exchange Commission (SEC) is known as a Registered Investment Adviser, or RIA.
3 Investment consultants advise on pension asset allocation and investment manager selection.
4 Professional ethics such as that of the Chartered Financial Analyst (CFA), Certified Investment Management Analyst (CIMA), etc.
5 See GFOA Best Practice, Investment Fee Guidelines for External Management of Defined Benefit Plans.
6 See GFOA Best Practice, Investment Fee Guidelines for External Management of Defined Benefit Plans.