Many IFAs have traditionally picked fund portfolios for their clients in the past but have employed little or no documented research in making their selections. Performance is generally poor, and in larger firms each adviser may have selected different funds for their clients and therefore there is no continuity within the firm.
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 reliably select portfolios for their clients have traditionally had three “outsourcing” options available to them.
Multi-manager funds
These 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 and fund of funds total expense ratios are generally more than 2 per cent, with many being considerably higher.
Recently there has been a move amongst 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 fund market.
These ‘Distributor Influenced funds’ have attracted adverse interest from the FSA due to the fact that they are generally more costly than mainstream funds of funds due to lack of scale, and they generate additional fees for the adviser firm leading to a potential conflict of interest.
Model Portfolios
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. These portfolios have typically been based upon a selection of active funds (similar to funds of funds) and the providers tend to be limited to research houses such as OBSR and fund providers such as SEI. While there is no specific charge for this service, investors face the underlying fund charges in full.
In a recent Guidance Consultation Paper (GC12/6) on Centralised Investment Propositions (CIPs) the FSA has flagged their concern over the use of DFM “one size fits all” model portfolio solutions. The words “shoe horning”, “churning” and “additional cost” regularly appear throughout the document and it is clear that the FSA have an issue with this type of restrictive investment approach within the definition of independence.
Discretionary fund managers
In its purest form this is perhaps deemed to be the most sophisticated option available. Traditionally, assets were transferred to the nominee account of the discretionary fund manager (DFM), although nowadays the assets can be managed remotely e.g. on wrap platforms. The DFM then has the power to manage the money as it sees fit.
The DFM will charge a management fee and many portfolios are built from collective funds, which 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 investment management process but will need to account to the client for any share of fees received from the DFM.
In the consultation same paper the FSA pointed out that where an IFA firm chooses to delegate a client’s discretionary management to a third party it can meet this requirement in two ways.
a) Arrange for the client to have a direct contractual relationship with the discretionary manager.
b) Retain responsibility for the discretionary management but outsource the actual management to a third party manager. The firm is still required to hold the relevant permissions for managing investments, even though it does not actually carry out the management.
This is all pretty clear cut. Where an IFA is using a DFM managed model portfolio solution on a platform and is assessing suitability itself, rather than allowing the DFM to do that, they must hold discretionary permissions and retain the requisite level of regulatory capital that those permissions dictate.
Furthermore, the act of placing a client into one of these DFM managed solutions does not in any way absolve the IFA of responsibility for suitability of the advice. This may not be the panacea that many early adopters thought they were buying into.
Andrew Whiteley is partner at Assetfirst
