Asset Manager Ethics: Investment Process and Actions

September 27, 2015 — 6:01 PM EDT

The global financial markets hold an appeal for professionals and individuals alike; both are hungry to match wits with the market, trying to beat it. However, investors often find themselves trumped by the market because it did not cooperate and behave as expected. Due to the difficultly in accurately predicting the market, professional asset managers tend to develop an investment process—a procedure they follow to manage client assets so that clients know what to expect from the manager and their investment.  

Investment processes are not invented on a whim, nor are they instantaneous. They are often honed over many years of trial and error, of examining and participating in the markets, during times of frequent wins and insurmountable losses. And these processes tend to be tested during different points in the economic cycle and are made to be repeatable. The belief is the process will provide the team (the manager and the client) with the best chance of “besting” the market to achieve their goals. (For more, see: Understanding Your Role in the Investing Process.)

Investment Process and Actions

Managers, in developing their investment process, need to determine some “general rules” that make it meaningful. Many adhere to guidelines provided by the CFA Institute. Although the CFA Institute is not a legal governing body, it is a professional trade organization that has a great deal of influence over the professional investment community. The CFA Institute provides an Asset Manager Code of Professional Conduct that lays out six guidelines related to the investment process and manager actions:

 1 . Managers must use reasonable care and prudent judgment when managing client assets. In other words, investment managers need to perform research and analysis and make decisions that make sense for the client based on how the manager agreed to manage the client’s portfolio.

2 . Managers must not engage in practices designed to distort prices or artificially inflate trading volume with the intent to mislead market participants. This means managers cannot spread false rumors or misleading information about a security. Nor can managers buy a large position in a security just to manipulate the price or trade in illiquid stocks at the end of a quarter to drive up the security’s price so that when they report their holdings to clients, the price looks higher. Although many of these actions may be difficult to prove, particularly with the increased trading volume and volatility attributed to high frequency trading, from an ethical standpoint, the asset manger’s process should preclude these types of activities.

3 . Managers must deal fairly and objectively with all clients when providing investment information, making investment recommendations, or taking investment action. Clients need to feel certain that they are being treated equally, that no other client is given preferential treatment that may negatively impact their portfolio. There are certain cases, however, when a manager may offer more premium services or products to a select group of clients (based on level of assets being managed, for example), but that manager needs to disclose these arrangements and make them available to all suitable clients.

4 . Managers must have a reasonable and adequate basis for investment decisions. This provision, in particular, gets to the heart of the investment process. Managers cannot randomly select investments for a client’s portfolio without a “reasonable and adequate basis.” The investment process must be designed such that the manager can reasonably analyze the investment opportunity, whether using fundamental or technical analysis, to formulate an investment decision that is well-informed, has been thoroughly researched, and considers assumptions and risks related to the timeliness of information, the type of instrument, and the objectivity and independence of any third-party research (for example Wall Street research).

5 . Managers need to only take investment actions that are consistent with the stated objectives and constraints of that portfolio and provide adequate disclosures and information so investors can consider whether any proposed changes in the investment style or strategy meet their investment needs. The manger’s investment process needs to be adhered to and clients need to trust that managers will stay true to their objectives. However, managers can also be granted some level of flexibility to take advantage of different market situations, but they need to communicate these decisions with clients. Communication should be on a regular basis, especially when managers deviate from their stated strategy. It is critical to keep clients well-informed and able to determine if the amended strategy meets their expectations.

 6 . Managers need to evaluate and understand the client’s investment objectives. Managers, in order to take appropriate actions on behalf of the clients, need to understand the client’s objectives. This is usually done in an Investment Policy Statement (IPS), which considers how much risk clients are willing or able to bear, expected return objectives, length of time until the assets are needed, short- and long-term money needs, liabilities (e.g. car loans, mortgages, etc.), tax impacts, and any legal, regulatory, or other unique circumstances. The IPS, which is reviewed annually or when a change in circumstance arises (such as a death or retirement), will help the manager choose investments that are appropriate for the client while also determining how the manager’s performance will be measured. (For more, see: An Example of an Investment Policy Statement.)

The Bottom Line

These guidelines may not be legally mandated, but they tend to follow the spirit of the law related to the Investment Act of 1940 and subsequent legal and regulatory requirements. More importantly, these guidelines help set expectations for both the client and manger to establish a clear understanding of goals and lay out a plan on how to achieve them in a fair, ethical and prudent manner.