Low profits may force DFMs to abandon model portfolios

Discretionary managers may have to abandon model portfolios on platforms as many services are struggling to generate a profit in the increasingly crowded market.

Many wealth management firms have launched model portfolios on platforms in recent years to take advantage of a predicted surge of interest in such services from advisers.

But in spite of considerable growth in the industry, not every firm has seen the benefits and some expect companies to start abandoning their models soon.

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Matthew Lamb, head of institutional and fund distribution (UK) at Gam, said he thought some discretionary fund managers (DFMs) were looking to close down their model portfolio strategies on platforms. Reasons given to Mr Lamb about the problems with model portfolios include the fact they are “too complicated to run”, low margins and they have “big tracking errors to the reference strategy”.

The tracking errors come from the process of quarterly rebalancing that is common for model portfolios. It means that if someone buys a model on a certain allocation, within the following three months market movements could have pushed the client further away from the original allocation, possibly taking him or her out of their risk tolerance.

Model portfolios suffer a number of other handicaps compared to unitised funds of funds. In addition to rebalancing issues, they are subject to VAT, adding 20 per cent onto the cost of the portfolio.

They are also limited in what they can buy as they can only purchase products that the host platform offers, whereas funds of funds have much greater flexibility in what they can buy.

The difficulties with model portfolios have led to more and more discretionary managers launching unitised versions of their bespoke mandates to offer clients an alternative.

James Calder, research director at City Asset Management (Cam), said the firm had far more assets in its unitised funds than in its model portfolios.

He said the models were not yet cost efficient but said Cam was taking a long-term view and was not giving up on the models.

But Mr Calder added that he expected DFMs to leave the market if they failed to hit profitability targets soon.

Part of the problem is the competition for business on model portfolios.

Bill Vasilieff, chief executive of Novia, said there were 44 DFMs with model portfolios listed on its platform.

He said he had noticed a real divergence in the assets going into the models, adding that investor money was mainly moving into products run by firms that were going out and marketing them strongly to advisers.