The Trustee’s Role as a Fiduciary: Duty To Your Investment Portfolio Mike Marsh, CFA Consultant | Manager, Investment Research Ryan Pickert Consultant | Client Development

Today’s Objectives Who is a Fiduciary? General Investment Governance Status, Requirements and Limitations of Being a Fiduciary

Who is DeMarche? Independent Institutional Investment Advisor Advisory and Discretionary Services Clients include major corporations, retirement funds, endowments, foundations and public funds 100% privately owned 45 years of experience

Global Fiduciary Precepts If an Investment Steward were to read all of the laws defining fiduciary obligations, the Steward would discover seven common requirements, which have been adopted in the fiduciary community as “Global Fiduciary Precepts.” Know standards, laws, and trust provisions Diversify assets to optimize risk/return profile Prepare detailed investment policy statement Use “prudent experts” (for example, an Investment Manager) and document due diligence Control and account for investment expenses (have a robust fee review process) Monitor the activities of “prudent experts” Avoid prohibited transactions and avoid or manage other conflicts of interest in favor of the portfolio

Who is a fiduciary? A fiduciary is a person who: Is the “named fiduciary” (a formal designation by the plan) Exercises discretion with respect to management or administration of the plan (Trustee, Administrator) Provides investment advice for a fee (Investment Consultant) Exercise discretion with respect to the management or disposition of plan assets, (Money Manager) Functional test focused on actual control and authority over plan

Who is a fiduciary? Activities that give rise to fiduciary status include: Being a plan sponsor Appointing other plan fiduciaries Selecting and monitoring plan investment options Selecting and monitoring third party service providers Interpreting plan provisions Exercising discretion in denying or approving benefit claims Providing investment advice for a fee (limited exception for general education advice or use of qualified investment advisor) Activities that are purely administrative in nature do not give rise to fiduciary status.

Investment Governance Roles & Responsibilities of Trustees Set broad investment policies/objectives for portfolios State law adopted in 1993 requires all Texas public retirement systems to adopt a written investment policy Identify rate of return Identify and evaluate risk Review policies annually, including asset allocation targets, if applicable Targets should be reviewed on the basis that these are long-term targets, and as such should include consideration of previously approved long-term risk/return objectives Adopt ethical standards and conflict-of-interest policies Develop a funding policy Education Empower others to manage day-to-day operations

Investment Governance Roles & Responsibilities (continued) Investment Consultant Develop and maintain investment policies Portfolio construction (e.g. asset allocation, diversification, style) Selection of investment managers Due diligence on investment managers Performance reporting on investment managers Investment Managers Delegated discretion to construct portfolios within areas of expertise Manage assets in accordance with policy guidelines

Investment Governance Investment Policy Specifies the procedures, guidelines, and constraints for decision making and management Road map that keeps organizations on path to achieving long-term goals Encourages disciplined process that improves chances of success Provides clarity to individual managers on guidelines for implementing their strategies

Investment Governance Investment Policy (cont.) Factors to consider Time Horizon Liquidity Transparency Downside risk aversion Restrictions (prohibited transactions) Starting point matters

Why does a starting point matter?

Investment Governance Risk Evaluation Risk is prevalent across investment spectrum Organizations should identify and prioritize key risks and metrics to quantify tolerances; consistent with ability to financially, politically, and publicly withstand downside risk Investment policy must represent ability to withstand: Risk of loss – financially, politically, and publicly Risk of shortfall to required return

Limitation of Fiduciary Status How does a fiduciary mitigate his/her scope of fiduciary function? Delegate – Appoint investment manager Plan design Hire experts to educate and advise How does a fiduciary terminate his/her role? Must follow plan procedures Must make sure a successor fiduciary is in place You are a fiduciary until you appropriately resign or are removed and there is a successor

General Fiduciary Requirements ERISA Section 404(a)(1) - A plan fiduciary has the following affirmative duties (“The Five Duties of a Fiduciary”): Duty of Loyalty – to act solely in the interest of participants and with the exclusive purpose of providing benefits to them Duty of Documentation – a written IPS must comply with the provisions of the plan to the extent consistent with ERISA Duty of Prudence (i.e., duty of care or “prudent-person rule”)* Duty of Diversification – to diversify the assets of the plan to minimize the risk of large losses Duty to pay only Reasonable plan expenses A plan fiduciary is also subject to a set of express prohibitions *The prudent-person rule (also known as the "prudent man rule") is a legal maxim restricting the discretion allowed in managing a client's account to the types of investments that a prudent person seeking reasonable income and preservation of capital might buy for his or her own portfolio.

ERISA versus Non-ERISA The Employee Retirement Income Security Act of 1974 (ERISA) is a federal law that sets minimum standards for most voluntarily established retirement and health plans in private industry to provide protection for individuals in these plans Must follow ERISA's reporting requirements Non-ERISA Governmental plans are exempt from ERISA coverage Must follow the financial measurement and reporting requirements imposed by the Governmental Accounting Standards Board

Duty of Loyalty Act solely in the interest of participants and beneficiaries with the exclusive purpose of providing benefits to participants and beneficiaries Avoid self-dealing or preferring interests of third- parties over participants and/or beneficiaries Don’t mislead participants and/or beneficiaries Vigorously pursue rights of participants and/or beneficiaries

Duty of Documentation Discharge duties in accordance with the documents and instruments governing the plan Documents include: plan document, summary plan description, trust agreement, investment management agreements, and investment policies As a Committee member, read and make sure you understand plan documents and ensure your decisions are consistent with them

Duty of Prudence “Prudent Expert” Rule Discharge duties with the care, skill, prudence, and diligence that a prudent person acting in a like capacity would use in like circumstances Prudent Expert Rule focuses on conduct Doctrine of “Procedural Prudence” (means process > outcome). Courts emphasize fiduciary’s conduct, investigative diligence, and acting consistently with the purpose of the plan over results. Fiduciaries need not guarantee success of decision, but rather show that it acted prudently in making the decision

Duty of Diversification Minimize risk of large losses by diversification unless, under the circumstances, it is clearly prudent not to do so The following factors should be taken into consideration: Purpose of the plan, Amount of the plan assets, Type of investment, Geographic distribution, Distribution as to industries, Maturity date All plan assets and not any particular sub-fund Limited relief through plan design

Duty to Pay “Reasonable” Plan Expenses Plan assets may be used for two purposes: To pay benefits To pay reasonable expenses of administering the plan Prudent-person rule requires that fiduciaries identify fees and ensure they are “reasonable” Review all service provider fees for reasonableness

Prohibited Transactions Fiduciary is precluded from causing a plan to engage in a transaction which constitutes a direct or indirect Sale, exchange, or leasing, of any property between plan and “parties in interest” (PIN) Lending of money or other extension of credit between plan and PIN Furnishing of goods, services or facilities between plan and PIN Transfer to, or use by or for the benefit of, PIN, of any assets of plan, or Acquisition, on or behalf of plan, of any employer security or employer real property in violation of ERISA § 407(a) “Parties in interest” include, among others: Any plan fiduciary (including, but not limited to, any administrator, officer, trustee or custodian), counsel or employee of plan; a person providing services to plan; an employer any of whose employees are covered by plan; or an employee organization any of whose members are covered by plan

Prohibited Transactions In addition, a plan fiduciary may not: Deal with the assets of the plan in his or her own interest or for his own account Act in any transaction involving the plan on behalf of a party whose interests are adverse to the interests of the plan or to the plan participants and beneficiaries Receive any consideration for his or her own personal account from any party dealing with the plan in a transaction involving the assets of the plan

Recap and Call to Action Understand your fiduciary responsibilities as a trustee Develop an investment policy Follow established policies and procedures Partner with industry experts

Commitment to Clients and Education DeMarche is committed to exceeding client expectations through our leadership in research and education. Programs in Finance and Investments DeMarche hosts workshops across the country each year for institutional investors. These free programs feature our consultants, together with top investment experts, for discussions of critical investment topics, market forces and industry trends. Customized Workshops and Seminars We develop and tailor educational sessions to meet the needs and requests of our clients. These can cover a wide range of topics including fiduciary responsibility, emerging asset classes and new investment policy strategies. Reports and Analysis Capital Market Review Economic Outlook DeMarche Dashboard Client-directed Research Initiatives Annual Client Conference Our annual two-day client conference is held each fall. Now in its 36th year, the conference features timely discussions by leading investment professionals, academics and DeMarche consultants on issues that impact investment strategies and portfolio returns. Speakers Bureau We provide our industry experts to speak at national conferences and regional workshops on topics relevant to institutional investors and financial executives.