InvestmentsMay 1 2013

Investment insight: DFM model portfolios

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Outsourcing solutions have been attracting significant attention for some time, prompted by the advent of the RDR. A key development in this area is discretionary fund manager (DFM) model portfolios, a way for clients with lower assets than typical discretionary minimums to access a form of bespoke management.

Research recently published by Investec Wealth & Investment said 47 per cent of advisers currently use DFMs and an additional 10 per cent are planning to do so. There are a variety of reasons for this: 89 per cent said they wanted to delegate the day-to-day investment management process; 82 per cent valued the ability to gain access to an investment professional; and 73 per cent cited a reduction in their administrative burden.

For high-end clients a full, bespoke DFM service may be appropriate. But for clients with less money to invest, a model portfolio is one way to access the skills of a full-time manager without paying a small fortune.

What are they?

Many DFMs have realised that advisers are looking to outsource investment decisions. Most have traditionally been the reserve of very high-net-worth clients, beyond the realms of a typical adviser’s client bank. But with the RDR now in full force, DFMs have developed a method of providing an outsourcing solution for advisers and clients in the form of model portfolios.

Instead of full-blown discretionary management, a DFM model portfolio is open to any investor with the required minimum sum. All monies are managed under the same investment strategy. The discretionary manager makes allocation decisions and they work within a particular remit – income, growth or a defined level of risk, for example.

A DFM model portfolio is broadly comparable to a multi-manager fund, but the portfolio is not unitised. Some DFMs do, however, offer a unitised version of their model portfolio, allowing access for investors with even lower levels of capital than required for the portfolio.

Benefits and drawbacks

The main benefit of a DFM model portfolio is that it allows access to a discretionary manager at a lower cost and a lower asset barrier. If your business model does not support in-depth fund selection but your clients do not warrant a full discretionary service, a model portfolio might be an appropriate solution.

It also allows you to spend more time focusing on the client’s goals and overall financial planning, while allowing someone with the right expertise to worry about specific fund allocation. An additional layer of cost is added on, however, which must be justified by a better client outcome than not using one.

Advisers remain responsible for choosing the right model; the discretionary manager must ensure they work within the remit stated by the portfolio. If the client has assets elsewhere, it is important to ensure they do not conflict or double-up with the model portfolio, which could affect the overall risk level. Transferring in specie may be an option for at least some assets, but could come with an additional cost.

Risk is another key point. It may seem obvious, but a risk level five on a risk-profiling tool may not match a DFM’s level five, and two DFMs’ ratings may not match one another.

The relationship must also be managed. Discretionary model portfolios are increasingly available on platforms, in which case the manager is accessed at arm’s length and there is little risk of clients defecting to the DFM. Off-platform should not be a problem either as the whole point of model portfolios is that the client does not have a relationship with the discretionary manager; the adviser simply chooses the right portfolio as they would any other investment.

The point at which waters start to muddy is if the client has more money to invest or tweaks to the portfolio become necessary, in which case a bespoke solution starts to look more appropriate and a three-way relationship needs to be managed.

What’s out there?

The latest DFM research from Defaqto showed 65 discretionary management services offering a model portfolio solution. The 22 of these awarded a five-star rating are shown in Table 1.

A vast array of approaches is used, even among the top-rated managers. There are many elements for advisers to take into account when selecting a DFM model portfolio. Some, such as Saltus Fund Management, offer just three portfolios. At the other end of the scale there is North Investment Partners that offers 12. The average is around six.

The average funds under management is £1.75bn, encompassing a wide range from £50m managed by North Investment Partners to £3.75bn under Brooks Macdonald. Even this could have an impact when choosing the right manager; a large one is more likely to benefit from the economies of scale, but smaller managers might argue they can provide a more personal service, orthat their lower assets reflect an acceptance of lower levels of business.

Another consideration is how much business a DFM does through financial advisers – those who work with advisers most of the time will have more experience of intermediary-specific needs. Six managers in the Table gain business exclusively through advisers: Berry Asset Management, Brooks Macdonald, North Investment Partners, Octopus Investments, Standard Life and Wells Capital Investment Solutions. A low figure need not mean poor service for advisers though, as some will only just have opened up to the adviser market.

Minimum investments required vary hugely but are lower than amounts needed for a bespoke service, which can spiral into millions. Only Octopus has no stated minimum followed by North Investment Partners as the next lowest at £1,000. Heartwood and Thurleigh require at least £500,000 to access their model portfolios. The median requirement is £50,000.

Chart 1 and Chart 2 show two sample growth portfolios from Brooks Macdonald and North Investment Partners on a middle- to high-risk basis, although the two are not directly comparable as they

use different risk scales. They show the wide range of investments used to build discretionary portfolios, a breadth that individual investors may struggle to access on a cost-effective basis without assistance.

Where next?

While many advisers may have in-house model portfolios, a focus on efficiency post-RDR means deciding whether an outsourcing solution is actually better for the client instead of spending time directly managing investments. DFMs may have previously seemed inaccessible, but with model portfolios increasingly available on platforms at a lower investment threshold than a full service, they have now become one of a range of outsourcing options for advisers to consider.

Five questions to ask:

1. Is the model portfolio on a platform? Using a model on a platform you already use will provide easier access. However, only considering those on your existing platform may not be in the client’s best interests; you may need to go off-platform or use another.

2. How does your risk-profiling tally with the model portfolio provider’s rankings? Many model portfolios are risk-profiled, but it is your responsibility to assess your client and ensure you choose the right option.

3. Can existing client assets be transferred into the model portfolio? If not, it will be necessary to consider how existing holdings might conflict with asset allocation in the model portfolio.

4. What is your client’s tax position? Depending on their circumstances, it may be more appropriate to be in a model portfolio, a full DFM solution or even a unitised model portfolio.

5. Are the added costs justified by the benefits? Using a DFM model portfolio rather than a solution you could design yourself, or even a multi-asset fund, must add value for it to be worthwhile.