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Discretionary vs. Directed Investment Risk. By: Melody Bohlmann IM&T Investment Risk Manager Wells Fargo Wealth Management Group. Key Risks. Operational Risk Market Risk Business Risk. Operational Risks. You have them whether you have discretion or allow for direction

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Discretionary vs. Directed Investment Risk

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discretionary vs directed investment risk

Discretionary vs. Directed Investment Risk

By: Melody Bohlmann

IM&T Investment Risk Manager

Wells Fargo Wealth Management Group

key risks
Key Risks
  • Operational Risk
  • Market Risk
  • Business Risk
operational risks
Operational Risks
  • You have them whether you have discretion or allow for direction

Example: IM/Asst. input trade incorrectly –

wrong asset – incorrect ticker,

wrong amount - shares, units, dollars

  • What is different is disputes – internal vs. external
operational risks1
Operational Risks

Ways to mitigate internal vs. external risk:

  • Require direction via:
    • Recorded phone lines
      • Issues:



    • Written direction only
      • Fax
      • Email
      • After the fact confirmation
      • Issues:


Follow-up monitoring

Can be addressed with appropriate language in

governing instrument and disclosures

operational risks continued
Operational Risks continued

You also have the following operational risks:

  • Asset set up
  • Dividend/Income processing
  • Pricing/valuation

The difference is that when you are purchasing discretionary assets you generally have a controlled process for ensuring that they happen correctly

operational risks continued1
Operational Risks continued

Soft dollars – Section 28(e) safe harbor - only commissions from discretionary trades can be used for research or services

market risk
Market Risk
  • Market movements - timing difference between time of direction and execution
    • Errors – do you make client whole, how do you make client whole
      • Gains vs. losses
      • Tax effects
      • Performance differentials
  • Long-term difference between value of asset directed and what could have been
    • Do you have an obligation to monitor the asset?
    • How are they monitored
issues to address when deciding on an individual account level
Issues To Address When Deciding on an Individual Account Level
  • Authority
  • Purpose
  • Type of Account
  • Investment Objective
  • Asset allocation
  • Diversification
  • Risk Mitigation
business risk
Business Risk
  • Firm decision vs. individual client and individual asset decision
    • What does the competition do
    • Will a decision not to allow for direction cause the business line to lose business to the competition
    • What does it cost firm to allow direction and put in proper controls and monitoring

Reputation, Operational, Investment risks:

if we do,

if we do but don’t do it properly or monitor properly, or

if we don’t

– same questions should be asked on individual account

and individual asset level


What does the governing document say?

  • Sole
  • Shared
  • Allow for direction

Purpose of the Account

Purpose of the proposed investment

type of account
Type of Account
  • Agency
  • Revocable
  • Irrevocable
uniform prudent investor act 2 b
Uniform Prudent Investor Act §2 (b)

“A Trustee’s investment and management decisions respecting individual assets must be evaluated not in isolation but in the context of the trust portfolio as a whole and as part of an overall investment strategy having risk and return objectives reasonably suited to the trust.”

184 185 restatement of trusts second 9 uniform prudent investor act
§184 & 185 Restatement of Trusts, Second & §9 Uniform Prudent Investor Act
  • Scope of duty under trust or agency agreements
    • Expectations of the parties reflected in the compensation paid for the duties undertaken
    • Reasonable expectation of the bene/principal based on the representations and conduct of the institution
    • General duty of directed trustee to reject directions or seek instruction where the direction facially constitutes a breach of trust - which violate either the terms of the agreement or general fiduciary principles
investment objective asset allocation
Investment Objective & Asset Allocation
  • How does the investment proposed fit with the investment objective of the account
  • Does it take into account income, principal and/or remainder bene’s
  • Is the asset a type that is one of your firm’s asset allocation types
  • Will a re-allocation be needed if the asset is accepted
asset set up pricing valuation
Asset Set Up/Pricing/Valuation
  • Do you have the appropriate types of asset codes to ensure that the asset is set up properly and can be monitored
  • Will the pricing feeds automatically price the asset or will manual pricing be necessary, if manual necessary what will the pricing be based on and how often updated?
  • Will the valuation meet regulatory/legal requirements
  • Generally required
  • What is your policy
  • Will the acceptance of the asset cause a concentrated position, concentrated asset type, sector, industry