The last five years has seen an explosion of interest in discretionary management from financial advisers.
There have always been a handful of discretionary managers that have historically served the adviser community, but Defaqto now covers some 80 discretionary firms offering upwards of 180 discretionary solutions, and this number continues to grow. So what has changed ?
The ‘noughties’ saw exceptional growth in assets under management for multi-manager funds, growing from around £11bn at the beginning of the 2001 to in excess of £60bn in 2011. This was perhaps the first indication that there was an appetite from advisers to outsource some or part of their investment process.
It is fair to say that this growth in assets did not go unnoticed by the discretionary industry. If we couple this with the implications of the retail distribution review which began to evolve later on in that decade, it was a perfect opportunity for discretionary managers to target or, in some cases target again, the adviser distribution chain.
The retail distribution review has been the real catalyst in the growth of discretionary management in the adviser space. As far back as 2010, implementation of the retail distribution review policy looming at the end of 2012 encouraged adviser firms, perhaps for the first time, to think seriously about their business strategy and what services they will offer. Near the top of the ‘to do’ list was how to deal with clients’ investment portfolios.
Do not forget there were a series of market falls, culminating in the collapse of Lehman Brothers in 2008, followed by a period of very uncertain and volatile markets. This will already have led many advisers to consider their position in terms of management of their clients’ investment portfolios. The approach of the new distribution era will have served to really focus their minds on this matter. Advisers were starting to realise that outsourcing to full-time, well resourced investment professionals was in the best interest of clients.
Multi-managers and multi-asset managers were the first beneficiaries of this, and continue to be so with the evolution of risk-targeted funds. However, discretionary firms were changing fast to give advisers another outsourcing option.
The biggest hurdle to overcome, was an acceptance that to penetrate the adviser market the discretionary firms would have to give up custody of the assets. Traditionally, this had been how they had measured their success. Perhaps an accident of history but, with a few exceptions, platforms had engrained themselves in adviser businesses before discretionary management presented themselves to this market as a real outsourcing option.
Any investments held on a platform meant that the platform had to hold custody of the assets. This included discretionary assets. As is often the case, once a few discretionary managers had accepted this, more and more very quickly followed. Defaqto have recorded in excess of 50 managed portfolio services available through a platform.
In essence there are two types of discretionary solution: bespoke portfolio management and managed portfolio services. The latter can be sub-divided further in to two further categories: MPS direct with the DFM firm and MPS accessed through a platform. This latter is perhaps the biggest development in the retail space.
Most platforms now have a very wide selection of discretionary portfolios to choose from. Novia, for example, have indicated that as much as 70 per cent of new business is invested in model portfolios (fairly evenly split between advised model portfolios and managed portfolios run and traded by the discretionary managers).
For the most part, discretionary managers have learnt quickly that advisers require information to help make their selections. More importantly, they require it in a format that works for them. For their part, advisers are beginning to understand that discretionary managers, in the main, are not building portfolios solely to achieve outperformance. Most discretionary firms construct portfolios in order to achieve a defined outcome for the client or client segment at the lowest possible risk. This is their priority and could mean comparatively lower returns, but at a reduced risk.
It has taken a little while, but advisers are now viewing portfolios in terms of achieving client goals and there is not necessarily any imperative to be beating the competition in terms of absolute returns. Portfolio risk has become much more to the fore in selecting portfolio managers. If client goals are achieved, taking as low a risk approach as possible is more appealing (and defendable) than possibly shooting the lights out on occasions, having a wild investment ride and potentially having it all go wrong at the wrong time for the client.
This changing attitude from advisers has meant that the discretionary managers are much more willing to provide information such as past performance, in the knowledge that it will not be mis-interpreted or mis-understood.
It inevitably took a little time for advisers to understand that they did not have to manage their client’s investment portfolios. Once it was accepted that the best outcomes for clients would be to put client portfolios in the hands of well resourced, full time professionals such as multi-asset managers or discretionary managers, it was difficult to argue against.
Indeed, in many cases it was more a case of persuading advisers to drop a part of their process that they probably enjoyed the most, returning to the fundamentals of financial planning and taking responsibility for sourcing the best investment options for their clients.
This should not be underestimated as a positive reason for outsourcing investment to discretionary managers, and to some extent multi-managers for that matter.
If advisers outsource the investment to a third party there is a subtle, yet very important, shift in the client/adviser relationship. The adviser and the client find themselves on the same side of the table, working together to find the best solution. Difficult conversations with clients are easier if the client and adviser are working together to achieve goals.
Discretionary managers keep the client and adviser informed through regular reports, usually issued half yearly or quarterly. Advisers and/or clients can also often access the portfolio, its value and transaction history online. This kind of transparency between adviser and client should lead to a much closer relationship.
Year on year, some observers have seen discretionary management assets grow with almost all discretionary firms (only five have seen a drop in assets).Will this continue? Regulation, the changing face of retail distribution, an understanding of the requirements and worries of advisers and discretionary firms respectively and simply an alternative choice to multimanager funds, have all contributed to the growth of this sector.
Of course, in this era of low interest rates, poor annuity rates and new pension freedoms, we would expect the discretionary industry to continue innovation and develop products and services to cater for this new market. While historically discretionary managers have focused on wealth accumulation and the protection of this wealth from generation to generation, decumulation is a word the firms will quickly get used to in order to compete.
Fraser Donaldson is insight analyst at Defaqto
Key Points
The RDR has been the real catalyst in the growth of discretionary management in the adviser space
Most platforms today have a very wide selection of discretionary portfolios to choose from
We have seen discretionary management assets grow with almost all discretionary firms
