An investment advisory agreement is a crucial legal contract between an investment advisor and its client. It lays out the terms of the advisory relationship, including the services to be provided, fees charged, and obligations of both parties. Understanding the key elements of an advisory agreement empowers investors to make informed decisions when engaging an advisor. This article will explain the core components of a typical investment advisory agreement in plain English.
The investment advisory agreement defines the scope of services
The most fundamental section of an advisory agreement specifies what investment services, advice, and recommendations will be rendered by the advisor. This delineates whether the advisor will provide comprehensive wealth management, portfolio management, financial planning, or more limited services. For example, the agreement may state the advisor will construct an investment portfolio, monitor its performance, and rebalance holdings periodically. The client and advisor should agree on what ongoing services will be provided before finalizing the agreement.
The investment advisory agreement specifies fees and compensation
A key part of the agreement addresses fees – how much the advisor will charge, how fees are calculated, and when/how they will be collected. The most common fee structure is an annual percentage of assets under management, such as 1% of AUM. However, some advisors charge fixed or hourly rates. The agreement should clearly state the advisor’s fee schedule and if there are minimum fees. It’s also important to understand fee billing methods. Many advisors deduct fees directly from client accounts quarterly or monthly.
The investment advisory agreement outlines client reporting
Reputable advisors provide regular reporting to clients on the services provided and status of their accounts. The advisory agreement spells out what reports, account statements, and reviews the advisor will furnish. For example, the advisor may promise to provide a quarterly performance report, monthly account statements, and an annual review meeting. More frequent reporting and transparency is generally favorable for clients.
The investment advisory agreement defines the account authority
A key consideration is what level of control and discretion an advisor will have over client accounts. Non-discretionary agreements require the advisor to receive client approval before executing any trades or transactions. Discretionary agreements grant the advisor authority to buy and sell investments in the client’s account without pre-approval. This section of the agreement should expressly state if the advisor will have discretionary or non-discretionary account authority.
The investment advisory agreement specifies the term and termination
Advisory agreements generally have an initial term of one year but automatically renew on an annual basis if not terminated. It’s important to understand the terms for ending the advisor-client relationship, as often 30 days written notice is required. Provisions for early termination, refund of prepaid fees, and the advisor’s obligations upon termination should be clearly defined.
An investment advisory agreement is the binding contract that governs the client-advisor arrangement. Investors should carefully review key elements like services, fees, reporting, account authority, and termination to ensure the agreement aligns with their expectations and interests.