1 When Members and Candidates are in an advisory relationship with a
client, they must:
a Make a reasonable inquiry into a client’s or prospective client’s investment experience, risk and return objectives, and financial constraints prior to making any investment recommendation or taking investment action and must reassess and update this information regularly.
b Determine that an investment is suitable to the client’s financial situation and consistent with the client’s written objectives, mandates, and constraints before making an investment recommendation or taking investment action.
c Judge the suitability of investments in the context of the client’s total
2 When Members and Candidates are responsible for managing a portfolio
to a specific mandate, strategy, or style, they must make only investment
recommendations or take only investment actions that are consistent
with the stated objectives and constraints of the portfolio.
Members in advisory relationships must consider the clients’ needs, circumstances, and objectives when determining whether an investment is suitable for the client. This information should be incorporated into a written investment policy statement (IPS) that addresses the client’s investment objectives and investment constraints. This IPS should be updated at least annually.
Determinations of suitability should be made in the context of a client’s overall portfolio. An investment with high relative risk may be a suitable investment in the context of a well-diversified portfolio.
If a client requests a trade that is unsuitable, the advisor should meet with the client to explain why it falls outside the IPS. If the client insists on making the trade, depending on the degree to which it deviates the advisor may require written acknowledgement of its unsuitability, modify the IPS, place the trade through an unmanaged account, or potentially even decide that they should not continue the advisory relationship.
When managing to an index or mandate, a manager should ensure that investments are suitable to the mandate. The decision as to whether the fund is suitable for a given investor can only be taken by those who have a direct advisory relationship with the client.
To comply with Standard I(C) members should maintain up-to-date investment policy statements for all clients. These should consider:
- Client information
- Nature and type of client
- Separate beneficiaries
- The proportion of the client’s assets being managed
- Investor objectives
- Return objectives
- Risk tolerance
- Investor constraints
- expected cash flows
- investable funds
- time horizon
- tax considerations
- regulatory and legal circumstances
- investor preferences
- proxy voting responsibilities and guidance
- Benchmarks for performance measurement
Advisors should also have clearly defined suitability criteria. These may include an analysis of how the investment affects portfolio diversification, a comparison of the investment’s risk to the investor’s risk tolerance, and how well the investment fits into the overall strategy.
The CFA Institute Standards of Practice Handbook provides several examples of potential suitability violations.
- Recommending similar investments for clients with different circumstances
- Buying a stock with characteristics that are outside a portfolio’s mandate
- Buying funds with a lock-up for a client with high liquidity needs
- Failing to conduct complete due-diligence on an external manager
- Investing outside of the IPS to seek short-term gains