What process should I go through to ensure a client's assets are appropriately diversified?
A fiduciary has a duty to diversify unless it is prudent not to diversify under the circumstances.
Initial Review and Timing of Action: The time frame in which a fiduciary takes over a new account and evaluates the account and all of its current assets should be based on the factors listed below. Some assets, because of their risk and volatility, will require immediate review and action, whereas less risky assets may be dealt with in a more deliberate and measured fashion.
- Nature of investment
- Risk involved in its retention
- Original value of account
- Cost basis of investment
- Immediate sale price compared to full value
- Immediate sale price compared to value at beginning of administration
- General state of market
- Available opportunities for reinvestment
- Question of tax liabilities
- Purposes of account
Standard Considerations: A fiduciary should consider the following factors when evaluating an account’s appropriate investment program or plan and whether to diversify:
- Terms of governing agreement
- Size of account
- Ability to obtain fair price for assets
- Availability of appropriate alternative investments
- Purpose of the account
- Tax consequences of sale
In establishing an investment program for an account, the fiduciary should also consider:
- Need for income or growth
- Other sources of income for client (if appropriate to consider)
- Income tax brackets of clients
- Objectives of client
- Terms of governing agreement
- Liquidity needs
Step One: Examine the governing agreement to determine what it requires concerning diversification and/or specific account assets. A governing agreement might contain:
- requirement of retaining inception assets
- permission granted for retaining inception assets
- silence on retention of inception assets
Step Two: Review file to determine whether the asset has been evaluated in the past. Look for, among other things:
- instruction or consent of clients
- co-fiduciary’s comments (and whether they have effective veto power)
Step Three: Determine whether the current investments provide any concerns about the following, taking into account the factors above:
- preservation of capital
- reasonable rate of return
Step Four: Identify assets to be sold. Any assets that represent undiversified portions of the account should be identified for additional in-depth evaluation and possible sale.
Step Five: Assign asset classes. Identify each asset by category:
- stocks (over concentration in a single company, industry, class or locality)
- bonds (over concentration in term range or obligor)
- mortgages (over concentration in term range or obligor)
- real property (over concentration in number of parcels, types or locality)
Assign assets per characteristics. Each asset should be identified based on certain characteristics that will be important to the purposes of the account.
- income potential
- size of company
Step Six: The evaluation should be compared with the client’s investment policies to determine whether it is compliant with such policies or if the account requires further, more specific evaluation.