The meaning of ‘fiduciary’ is suddenly up for grabs

Trust is a five-syllable word. That word is fiduciary. As investors discuss “gates” in hedge funds and losses in portfolios, the term “in a client’s best interests” is open to debate.

During the long-ago euphoria of soaring stock markets and hedge funds whose “consistent albeit mysterious” returns dazzled investors, few paid much attention to fiduciary duties.

The fact that all investment advisers registered with the Securities and Exchange Commission are bound to act as fiduciaries did not earn much press coverage. What that duty means in practical terms was an unlikely topic for client-adviser meetings in 2008.

If an adviser is bound to act in a client’s best interests, but as markets plummet the client is changing risk tolerance month-to-month, exactly what is the fiduciary duty? Some clients insist on superior relative returns in up markets, yet demand absolute returns in down markets.

If a client prefers not to document the investment mandate for the adviser, the question can be raised about whether the adviser should accept that client’s money without a “road map.” Also, will the investment document be too treacherous in this litigious society?

A mid-December investor survey by the New York-based Institute for Private Investors found that just 50% actually had such a policy written. Not surprisingly, many expected to make changes post-2008.

If a client wants to do something the adviser thinks is not in that client’s best interests, should the adviser ask the client to sign a document to that effect? And does the adviser risk losing this client as a result? After all, implicitly, the adviser is calling the investor not so smart.

The label “trusted adviser” has been worn as a sandwich board by the industry over the last decade. Will using the term “fiduciary” become just another tool in the sales kit? How will investors and advisers distinguish between those who really do act as prudent fiduciaries and those who just posture? Who is selling products, and who is truly offering advice?

One method of finding out is to turn to the increasing number of online communities of in-vestors. These networks have created a transparency never before available to clients of advisory firms. When an investor can query other investors on anything from the fees charged to how others’ advisers allocate to weather the market, the balance of power shifts noticeably to the client.

Today, the wealth management industry is in a state of fundamental disruption, with all the attendant opportunities for smart people.

There will be winners and losers, as there always are in any turmoil or revolution. After the market’s precipitous fall in 2008, many questions await candid answers before a clear direction will become apparent:

• Is the financial services industry destined to become the next Detroit?

• Does the exercise of evaluating the risk tolerance of an investor have to be totally overhauled and reinvented?

• Is the policy portfolio and re-balancing to that policy allocation “dead on arrival” in this bear market?

• Does the endowment model produce positive outcomes for a taxable investor?

• Will technology influence transparency?

• How will transparency affect conflicts of interest?

• Will the fiduciary standard make a comeback or be left for dead by our litigious society?

• Will the profession of wealth management bifurcate? Will one type of adviser engage in a deep dialogue with the family, while another crunches the numbers and invests the money? Will these two types be able to live under one roof at one firm?

• Will the single-family office make a comeback through technology and advanced outsourcing?

• How does the industry go about repairing trust or building confidence in the securities markets?

As frustrating as it is not to have all the answers to these questions, during times like these, the advice of scholar Peter Drucker, widely considered to be the father of “modern management,” seems more apt than ever: “The most serious mistakes are not being made as a result of the wrong answers; the truly dangerous thing is asking the wrong question.”

Charlotte B. Beyer is the founder and chief executive of the Institute for Private Investors in New York.