Standard III(C) – Suitability

Members and Candidates are in charge of managing a portfolio according to a specified mandate, strategy, or style; they must only make investment recommendations or conduct investment actions that are compatible with the portfolio’s stated objectives and limits. They should also make sure the investment is appropriate for the client’s financial circumstances and goals and mandates. Members and candidates should inquire about their investment experience, risk, and return objectives to establish a client’s suitability for a particular investment.

Application 1: IPS Update

Joseph Layfield has a financial portfolio worth USD 100,000. His father passed away and left him with a USD 5 Million inheritance. Over two years, Umar Farheed, his investment adviser, has not made any changes to his IPS. Farheed manages Layfield’s portfolio with the same objectives and constraints listed in his initial IPS.

Has Farheed violated Standard III(C) – Suitability?

1. No, he is managing Layfield’s portfolio in line with his IPS.
2. Yes, he has failed to update Layfield’s portfolio to incorporate Layfield’s change in circumstance.
3. No, Layfield’s inheritance does not materially change his objectives and needs.

Solution

The correct answer is B.

Layfield receiving his inheritance would be considered a material change in his circumstances. Layfield can assume more risk and can broaden his investment holdings. Farheed has violated Standard III(C) – Suitability by failing to update Layfield’s IPS to reflect his significant change in circumstance.

Application 2: Following an Investment Mandate

Travis Green is a portfolio manager responsible for InvesTank’s high-growth fund. He purchases high-income (low growth) stocks of several utility firms. He believes that these stocks are significantly undervalued and would provide a positive return for the fund.

Would Green’s purchase of high-income stocks violate Standard III(C) – Suitability?

1. Yes, because he is not following the fund’s investment mandate.
2. No, because he has the discretion of the fund’s stock selection.
3. No, because the potential upside to the fund from his selection would benefit the fund’s beneficiaries.

Solution

The correct answer is A.

Green has violated Standard III(C) – Suitability. The purchase of the high-income stocks does not fit the investment mandate (high-growth fund) that Green manages. Green must manage the fund according to the investment mandate of the fund.

Application 3: Suitability of an Investment

Jackson Howard, CFA, is a fund manager at BVG Inc. Jackson manages several pension funds. Recently, cryptocurrency has gained higher returns, as reported by a popular online crypto analyzer. Jackson recommends cryptocurrencies to several pension plans. Under the CFA Institute  Code and Standards, Jackson’s actions:

1. violated the CFA Institute Code and Standards
2. does not violate the CFA Institute Code and Standards as cryptocurrency would offer good returns.
3. does not violate the CFA Institute Code and Standards because cryptocurrency is a new asset class.

Solution

The correct answer is A.

For Jackson to recommend a security to its clients, it should ensure the investment is appropriate for the client’s financial circumstances and goals and mandates. Pensions are not allowed to take on a lot of risks, while cryptocurrency is considered very risky and would not fit into a pension fund’s portfolio.