DFMs and platforms – how to meet client needs

The removal of commission for new advice has motivated business-savvy advisers to recognise that the efficient delivery of expected financial planning outcomes drives a successful business, and creates satisfied clients.

Financial planning is a complex service requiring a high level of experience and qualification, and difficult to deliver without face-to-face advice.

The results can very clearly be compared to costs – the client receives a benefit through tax saved or capital efficiently created and dispersed, that is substantial compared to the cost.

Investment management is a separate and distinct skill; and some might claim it is an ‘art’. It carries significant risks for the client and the adviser business if not performed consistently, with robust governance and processes.

It should be no surprise then that adviser charging and need to manage operational costs has encouraged advisers to enthusiastically adopt centralised investment propositions in the form of model portfolios, and in many cases outsource completely to a discretionary fund manager.

The platform industry has seen huge demand for model portfolios. While it is estimated that only 20 per cent of platform assets are in models, this figure is depressed by 13 years of investment flows that had no modelling functionality to support them.

There is however a rising number of advisers who seek a means by which they can offer their clients a different way of achieving their goals. It must be underpinned by a believable and deliverable investment process designed and delivered by professional, and academically robust investment process, as opposed to “fund picking” or copy and pasting fund lists from research companies. A significant proportion of these advisers have decided to use discretionary fund managers (DFMs).

Where advisers have a discretionary solution in place, the onus has been on reducing costs by pressurising DFMs to blend passive solutions, and platforms to lower costs.

Many firms looking to implement a solution are demanding a much larger exposure to passive instruments as they seek to operate within the confines of a total cost of ownership that is significantly less than 2 per cent. Excess charges for delivery of alpha need to be justified with conviction and evidence.

DFMs on platforms are a relatively recent innovation and the process for using them has already started to evolve with advisers using several DFMs with different themes such as wealth preservation, socially responsible investing, passive and active, for example.

This helps the adviser to match the correct DFM to the client’s requirements and avoids the accusation of ‘shoehorning’ a client into a centralised investment proposition (CIP), but retains the operational efficiency of one administration platform. Once the correct DFM has been selected, the process for assessing the client’s attitude to risk begins. Matching this to the correct model highlights another potential issue.

The rising use of historic volatility as a basis for measuring risk, and ascribing that to models’ allocations, can present problems. Forward-looking assumptions are delivered by economic research businesses, and they are not cheap.

Where models do not invest in that data, outcomes may surprise, for example where a risk level ‘5’ ultimately performs like a ‘7’.

The FCA may follow thematic reviews into the use of CIPs and the onus is on the industry to ensure model solutions are robust and operate within a risk corridor that reflects the clients’ risk appetite.

Clients and their advisers need robust investment services that challenge the fund management industry status quo and that are focused on the client. Discretionary fund management can deliver that.

Paul Boston is sales director at Novia Financial

OUTSOURCING

It is estimated that only 20 per cent of platform assets are in models.

Where advisers have a discretionary solution in place, the onus has been on reducing costs by pressurising DFMs to blend passive solutions, and platforms to lower costs.