In this segment, we are examining the steps of a traditional investment management process and demonstrating how a principles-based fiduciary standard can be incorporated into the process. In addition, we are linking the leadership behaviors that are essential elements to the client relationship to the same decision-making process.

In June, we discussed the third step of the process: Formalize. This month, we move to the fourth step: Implement.

Implementation is what we use to translate strategy into reality. Step 4 will include an overview of a due diligence process that can be used to pick money managers; procedures on how to select the right investment vehicle to implement a client's strategy; and procedures to ensure that service agreements and contracts do not have provisions that conflict with the client's investment management program.

MONEY MANAGER SEARCH

It is difficult to develop uniform search criteria that can be applied to each asset class, and even more challenging if you are considering separate account managers as well as mutual fund managers. The best approach is to develop a process that you can apply consistently, communicate easily and use in both the search and monitoring phases of the decision-making process. Some points to keep in mind when you're developing your due diligence criteria:

* Simple is better than complex when operating in a dynamic environment.

* Know the strengths and weaknesses of your databases. For example, if a provider is reporting separate account returns, have the returns been independently verified or did the manager provide them?

* Know how peer groups have been constructed, particularly when comparing information on managers who are providing performance comparisons from different database providers.

* When comparing managers, make sure you are comparing statistics with the same endpoints and benchmarks.

INVESTMENT SEARCH

Now that you have defined the investment strategy and identified the money managers to implement the strategy, the next two decisions are whether to select a passive or active strategy and whether to engage a manager on a separate account basis or through a mutual fund or collective trust.

Passive or active? Much has been written about the virtues of both camps; here are the salient arguments:

* It's not an either/or decision; prudent investors will use both passive and active strategies in a portfolio.

* If the client doesn't care, go passive in implementing the large-cap core portions of the strategy. Go active in small-cap and emerging markets, where managers have a greater probability of finding a gold nugget that has not been discovered by Wall Street analysts who tend to focus on large-cap stocks.

* If you decide to go active, document the fact that you believe the added costs are justified. There is no regulatory or fiduciary requirement to choose the cheapest alternatives in building your client's portfolio, but you do need to be able to justify paying more for a service or product when there is a less expensive alternative.

* How strongly do you believe in the science behind asset allocation? The stronger your belief, the more faith you can put into passive investing.

Separate accounts or mutual funds? The client's account size may limit your choices to a mutual fund or collective trust. But improved electronic protocol between managers, custodians and intermediaries has made it easier for managers to lower account minimums, so you can access good managers on a separate account basis.

Just because your client meets the minimum for a particular manager doesn't mean that a separate account is the best vehicle, however. Here are some pros and cons for each type.

* Costs. Mutual funds spread their costs across all shareholders-positive if your client has a small investment, potentially negative if it's a large one.

* Performance information. In spite of technological advances, mutual fund databases are still a bit more reliable. In addition, mutual fund performance information is reported sooner than separate account data and probably always will be.

* Tax management. The taxable client, particularly one with low-basis stock, will likely fare better with a separate account manager who is willing-and able-to provide a tax-sensitive investment strategy.

* Phantom tax gain. Mutual fund clients may have unrealized capital gains tax liabilities in their portfolios.

* Fund liquidations and purchases. The mutual fund manager must contend with purchases and liquidations. This can be a major problem in a down market, when the investing herd sells out of a fund and forces the manager to sell securities against his or her better judgment.