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Conducting Due Diligence on Investment Strategists: Beyond Analytics

By Greg Gohr, AIF

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An advisor recently told me, “I really only focus on one consideration when choosing investments for my clients: their investment experience needs to match their expectations.” If he can accomplish that, the advisor explained—no matter the client’s objective or whether the portfolio beats its benchmark—he has done his job. 

Following this advisor’s lead, one approach to creating more predictable client outcomes might be to spend less time on screening mutual funds and more time educating clients on what to expect. For advisors who are trying to simplify their practices and enhance the client experience, partnering with an established investment strategist is an increasingly popular option.

Why Work With a Strategist?

Choosing the right strategist can create leverage by:

  • Minimizing the effort required to screen individual underlying investments
  • Providing a demonstrable track record, ideally through a full market cycle—to help identify how portfolios could react to different market environments
  • Freeing up time for other client-focused activities, such as education or comprehensive financial planning

Because there isn’t a widely available centralized database for strategists (like Morningstar), many advisors develop a pool of candidates based on peer recommendations or by researching providers. Once you’ve identified a few potential options, the due diligence phase can begin.

How to Choose a Strategist

At this point, you’ve presumably done some basic investment due diligence on multiple strategists to create a short list of contenders. Before doing the deep dive into their investment methodology, it may make sense to turn the due diligence process upside down and approach it from a top-down perspective. 

Start with a thorough scrub of the firm itself. If you’re affiliated with a larger practice, a dedicated due diligence team may do this on your behalf and provide you with summary documents. If you own the due diligence process yourself, you should develop a formal system that has two parts: firm-level and product-level (investment-focused) due diligence. Here are some high-level noninvestment considerations that are often overlooked:

1) General firm Information

Start by going to the SEC’s Investment Adviser Public Disclosure website and reviewing the firm’s Form ADV Part 1. This will provide you with basic information like number of employees, assets under management, disciplinary history, and ownership structure. You can also access the ADV Part 2 Brochures section, which will offer a more detailed view of the firm’s advisory business, including fee structures, brokerage practices, potential conflicts of interest, and more. Although reading ADV brochures can be tedious, they are the “source code” of the due diligence process and will give you a good sense of the firm’s primary business and the types of clients best suited to its services. 

2) Selling Agreement Structure

The legal agreement between the investment strategist, advisor, and client generally falls into one of two structures: a solicitor-based agreement or a co-advisory agreement. This is not merely a legal distinction and can have significant ramifications on your ability to service clients. 

      • Solicitor-Based Agreements Generally speaking, these are referral agreements, whereby you refer your client to a turnkey asset management platform or individual strategist, limiting your discretionary input at the account level. Under this structure, you are being paid for the referral and certain ongoing client-facing activities, like annual meetings and portfolio review, but you are not permitted to participate in the actual investment management of the account.
      • Co-Advisory Agreements Conversely, this type of agreement generally affords you a higher level of involvement in investment decisions and might permit you to make changes to the selected investment strategy without obtaining a client signature.

3) Custodian

Where does the strategist custody the client assets? Depending on your firm affiliation, certain custodians may not be allowed. If the strategist is only offered on custodial platforms that you have not previously used, this will likely introduce an entirely new set of operational considerations and client service issues for your staff. New account paperwork as well as custodian-specific policies around money movement, address changes, and more can have a significant impact on the client experience if not properly understood.

Perhaps even more important is data integration. Will the custodial data of your preferred strategist feed into your aggregation and performance reporting package? This is much less of a concern today than it was even a few years ago, as most custodians are compatible with the major aggregation providers, but it’s definitely worth confirming before making a decision. 

The Value of a Comprehensive Approach

Plenty of good investment strategists are available in the marketplace. Ultimately, however, client outcomes may largely depend on your ability to match the experience to the client’s expectations. A more comprehensive approach to vetting the noninvestment aspects of your strategist partners might not be as intellectually satisfying as investment analysis, but it may well enhance outcomes for both your clients and your practice.