Feature Articles and Resources

• Choosing the Right Investment Adviser
  
• Top Nine Pitfalls When Hiring an Investment Adviser
  
• Tips for Checking Out an Investment Adviser
  
• Useful Resources on Investment Advisers

• Panel of Economists: Economic Forecasts
  
• Interest Rate Outlook
  
• Snapshot of Economy and Interest Rates

• Performance Benchmarks
  • 10-Bill Index
  • Money Market Fund Index
  • LGIP Index
  • Key Rates: Cash Markets
  • Relative Value Yield Chart

Choosing the Right Investment Adviser

The use of investment advisers continues to grow in the public sector. As the duties and responsibilities of the finance officer continue to increase, one solution is to look at outsourcing the investment management function to the private sector. Choosing the right investment adviser is vital. The following article explores the use of investment advisers and suggests steps that can be taken to make the right choice. When contemplating the decision to outsource the investment management function, there are several key questions that should be considered.

Why Hire an Investment Adviser? Hiring an investment adviser can be beneficial in several ways.

• Complement internal resources. The government entity may be unable to devote full-time staff to managing the portfolio. Using an investment adviser to manage a portion of (or the entire) portfolio can enable the government to pick up some “added value” and direct internal staff to other duties or functions.
  
• Access to capital markets. An investment adviser can provide a way to participate in markets or sectors that otherwise may be beyond the government entity’s scope of expertise. For example, investing in corporate notes and bonds requires sophisticated credit analysis. Governments may not have in-house capabilities to do this type of analysis but an investment advisery firm does.
  
• Economies of scale. Larger trades, achieved by combining purchases for several portfolios, will generally result in better yields and lower transaction costs.
  
• Expertise. The investment adviser will add a stronger investing discipline and investment expertise.

How Is an Investment Adviser Selected? Governments should begin the selection process by discussing and writing out their goals and objectives. These goals and objectives should coincide with the investment policy. If they do not, then the investment policy will need to be revised. The government will also need to determine which type of manager they are looking for – non-discretionary or discretionary. Once the government knows what style and types of services it needs, a request for proposal (RFP) can be prepared and sent to several prospective advisers that meet the criteria. Prior to the issuance of the RFP, the government entity should also develop the criteria on which the adviser will be selected.

Role of the Non-discretionary Manager. A non-discretionary manager is typically selected when the asset owner wants to remain actively involved with the investment process. The investment manager must obtain approval for individual transactions, and the government entity is involved in the decision-making process. All transactions may be handled by the government entity with advice and assistance of the investment adviser. One note to consider is that there are fewer non-discretionary managers than discretionary managers.

Role of the Discretionary Manager. A discretionary manager manages funds without consulting the government entity for each trade. This type of management is done using the investment policy as the basis for all investment decisions and transactions. Typically, the cost of management is negotiable but will be more expensive than non-discretionary management. The government entity might consider using commingled funds rather than separate account management if the fund’s investment constraints comply with the government entity’s investment policy or if the government entity has a portfolio of less than $10 million.

Regardless of what type of investment manager is selected, the government entity should always use its own safekeeping agent to hold all securities purchased. In addition, the government might consider the use of an independent investment performance-reporting agent to verify the firm’s performance reporting, at least on an annual basis.

Selecting a Manager. The next step involves compiling the responses to the RFP, comparing them to the selection criteria, and analyzing and verifying the data provided. A risk/return analysis should be conducted to measure the benefits of using an investment adviser against the added costs of the service. Some governments may be unable to pick up added value because of conservative investment objectives and low risk tolerance, but may be able to benefit in other ways, such as improved credit quality, economies of scale, and enhanced internal controls. All of these factors should be considered in the analysis.

Finalists should always be interviewed face-to-face. Following the interviews, another analysis should be completed to incorporate any new information that was received during the interviews. The candidate that most closely meets the government’s desired style and needs should be chosen. If those involved in the selection process are not impressed with the finalists, the process should be started over again, but not before the government reviews its expectations and selection criteria. The investment adviser chosen must meet the government’s desired style and needs, and the government’s staff must feel comfortable working with the adviser.

Top Nine Pitfalls When Hiring an Investment Adviser

Below are nine common mistakes made when hiring an investment adviser. Keep these in mind during the hiring process. Past performance was too good to pass up. Impressive numbers are probably the most overrated criterion for selecting an investment adviser. Again, past performance is no guarantee for future performance. Also, watch out for the presentation of composite and individual portfolio performance numbers. When analyzing composite performance make sure the securities in the composite are allowable securities for the government entity and check the weighted average maturity or duration to see if it coincides with the government’s investment objectives. It is important to compare similar “styles” of portfolios. Also, make sure that the portfolios are compared for the same time period. It is important to get performance figures on individual portfolios that most closely resemble the kind of portfolio the firm will be managing in terms of size, investment style, and objectives. The firm was “hot.” Today’s “hot” manager could be tomorrow’s loser. The firm’s client contact was aggressive and persistent. Don’t misconstrue marketing savvy for investment expertise. Hire the latter, not the former. The firm chosen was the one that made the best presentation. Don’t allow the selection process to become a beauty pageant. Don’t get sidetracked by less pertinent details and lose focus. The firm came highly recommended. Although it is important to network with others, make sure that it is an “apple to apples” recommendation and that the person making the recommendation has a similar portfolio and management style. The adviser will manage all of the assets. Don’t just hand over all of the government’s funds and fall for the “trust me” routine. Even if the adviser is managing the total portfolio, government officials must stay involved in the process and monitor the investment adviser’s performance and compliance to the investment policy. The governing body did not consider the benefits of hiring more than one manager. There is a pro and con to hiring more than one manager: Pro: The hiring of a second manager can be considered a safety valve and provides the government with the option of diversifying by management style. Con: By cutting the portfolio pie, potentially attractive advisers may be eliminated because of the minimum account sizes required by some firms. Also, cutting the portfolio into smaller portions could result in higher fees. The firm was chosen because it had the lowest fees. The fee should not be the primary factor in the selection process, because there may be a good reason why the firm has lower fees. For example, if the investment adviser is investing in a commingled fund, the fee will be lower. Or the lower fee could be because the firm is new and has an “introductory” rate. Often, firms with poor performance will have lower fees. We did not do on-going due diligence. Due diligence does not stop once the manager is hired. The government entity should do formal ongoing performance monitoring and manager due diligence.

Government officers moving in the direction of hiring investment managers should make sure to have a complete understanding of what it is they want to accomplish. Be sure and do the homework during the selection process. It will pay off in the long run. And remember, once an investment adviser has been hired, a new partnership has been formed and the relationship should be approached as such.

STAN HELGERSON is finance director for the Village of Carol Stream, Illinois, and is a member of the GFOA Executive Board.

Tips for Checking Out an Investment Adviser

Federal or state securities laws require brokers, advisers, and their firms to be licensed or registered, and to make important information public. But it is up to you to find that information and use it to protect your investment dollars. The good news is that this information is easy to get, and one phone call or Web search may save you from sending your money to a con artist, a bad broker, or disreputable firm. 

Before you invest, make sure your brokers, investment advisers, and investment adviser representatives are licensed to sell securities. Always check and see if they or their firms have had run-ins with regulators or other investors. This is very important, because if you do business with an unlicensed securities broker or a firm that later goes out of business, there may be no way for you to recover your money — even if an arbitrator or court rules in your favor.

People or firms that get paid to give advice about investing in securities generally must register with either the Securities and Exchange Commission (SEC) or the state securities agency where they have their principal place of business. Investment advisers who manage $25 million or more in client assets generally must register with the SEC. If they manage less than $25 million, they generally must register with the state securities agency in the state where they have their principal place of business.

Some investment advisers employ investment adviser representatives, the people who actually work with clients. In most cases, these people must be licensed or registered with your state securities regulator to do business with you. So be sure to check them out with your state securities regulator. 

Check the Investment Adviser's Form ADV. To find out about advisers and whether they are properly registered, read their registration forms, called the "Form ADV." The Form ADV has two parts. Part 1 has information about the adviser's business and whether they've had problems with regulators or clients. Part 2 outlines the adviser's services, fees, and strategies. Before you hire an investment adviser, always ask for and carefully read both parts of the ADV.

You can view an adviser's most recent Form ADV online by visiting the Investment Adviser Public Disclosure (IAPD) Web site. At present, the IAPD database contains Forms ADV only for investment adviser firms that register electronically using the Investment Adviser Registration Depository. In the future, the database will expand to encompass all registered investment advisers—individuals as well as firms—in every state.

You can also get copies of Form ADV for individual advisers and firms from the investment adviser, your state securities regulator, or the SEC, depending on the size of the adviser. You'll find contact information for your state securities regulator on the Web site of the North American Securities Administrators Association.

Investment-Related Sessions at the GFOA Conference

The upcoming GFOA conference in Anaheim, California, on June 10-13, 2007, will include the following sessions related to investment of operating funds. More information on the GFOA conference is available online.

Hitting a Moving Target: Investing in a Changing Interest Rate Environment
How should you invest your short-term funds in the current interest rate environment? Should you use a bullet or ladder strategy? What instruments, strategies, and techniques are best suited to the current environment? At this session, experienced portfolio managers will share the latest investment tips and strategies for short-term (non-pension) investing in today’s market.

Choosing and Using An Investment Advisor
Governments are increasingly turning to investment advisors for help in investing operating funds. Governments need to know what the options are and how to make the best choices. Based on GFOA's new publication, An Introduction to Investment Advisors for State and Local Governments, this session will feature discussions on the advantages and drawbacks of using investment advisers and best practices for selecting and engaging investment advisers.

Measuring Portfolio Performance – Total Return versus a “Beyond Total Return” Fiduciary Standard
How to measure the performance of a government investment portfolio is an important and much debated issue in the public investing world. On one side of the debate are those who argue that the total return of the portfolio is the best measure. On the other side are those who argue that a fiduciary standard established in a government’s investment policy should be used to manage and measure public investment portfolios. Hear opposing views from leading proponents of each of these two very different methods.

Economic Forecasts

This month, Public Investor asked its panel of economists to provide their forecast of the economy over the next six months commending on economic growth, inflation, and interest rates.

Peter Kretzmer of Banc of America Securities predicts real economic growth near 2.5 percent for the first half of the year, implying a modest slowing in the labor market. He expects consumption to remain firm and for weakness in residential investment to continue (but dissipate). Kretzmer predicts that the Fed will remain on hold for the first half of the year, and expects interest rates to rise modestly. In addition, core measures of inflation should continue to drift down slowly.

Lacy Hunt of Hoisington Investment Management notes that nominal GDP in 2007 could approximate a 3 percent growth rate – which would be the slowest in almost 50 years. However, this low rate of nominal growth would not indicate a recession since a 1.5 percent inflation rate would result in a real GDP expansion. He adds that this environment should provide for record low bond yields this year.

Gary Thayer of A.G. Edwards expects the economy to continue to expand at a sub-par rate in 2007. He notes that the housing sector will remain a drag on economic growth, while U.S. exports are likely to slow as European economic growth cools off. He also expects inflation to decline modestly and for energy prices to be lower this spring than last year. Thayer predicts that the Fed will be able to cut interest rates slightly in the second half of this year if economic growth remains slow and inflation subsides.