Addressing regulators’ worries over outsourced investments
More on Discretionary Management
- Thesis launches model portfolios investing in direct...
- Discretionary Fund Management - October 2014
- Tracking the performance
In focus: Outsourcing Investments
Many IFAs have traditionally picked fund portfolios for their clients in the past but have had little or no documented research behind their selections.
Performance is generally poor. In larger firms, each adviser may have selected different funds for their clients and therefore there is no continuity within the company. The FSA will not view this favourably in the future and unless the IFA firm is willing to employ a specialist investment professional – at significant additional cost – to monitor and research their fund selections this may well prove to be a compliance problem in the post-RDR world.
IFAs that do not have the internal expertise and capabilities to select portfolios reliably for their clients have traditionally had three ‘outsourcing’ options available to them.
Funds of funds and other multi-manager funds are packaged solutions where typically one overarching fund manager will select ‘best of breed’ funds within a particular market or sector with the aim of delivering outperformance through regular monitoring and alterations to the underlying portfolio.
This double layer of management oversight leads to double charging. The total expense ratios of funds of funds are often more than 2 per cent, with many being considerably higher.
Recently there has been a move among some larger IFA firms to produce their own ‘in house’ funds specifically for their clients with the aim of delivering better returns than those available from the retail market. These ‘distributor influenced funds’ have attracted adverse interest from the FSA owing to the fact that they are generally more costly than mainstream funds of funds due to lack of scale and the fact that they generate additional fees for the adviser firm, leading to a potential conflict of interest.
In its purest form, discretionary fund managers (DFMs) are perhaps deemed to be the most sophisticated option available. Traditionally assets were transferred to the nominee account of the DFM (although nowadays the assets can be managed remotely on investment platforms) and then managed on behalf of the clients.
The DFM will charge a management fee and many portfolios are built from collective funds that carry additional annual charges. Total charges can easily exceed 3 per cent a year once all fees and dealing costs are added in. Crucially the IFA has no role in the management of the investments but will need to account to the client for any share of fees received from the DFM.
Some wrap platforms provide model portfolio options for IFAs using their service. These take the form of risk-graded portfolios which are rebalanced regularly (usually quarterly) and the adviser elects to rebalance their clients back to the current weightings on an ad hoc basis.