Investments  

Give DFMs their due

    CPD
    Approx.30min
    Give DFMs their due

    “Due diligence, or at least inadequate due diligence, underpins a lot of the incidents of crystallised risk we have seen.

    “You can rely on third-party providers for factual information but not for opinion. You have to come to your own view.” Rory Percival, FCA Technical Specialist, 30 September 2014.

    And so, as we see more and more intermediaries outsource investment management to discretionary fund managers (DFMs), we see a need, according to Mr Percival, not only for good due diligence to be readily available, but for intermediaries to come to their own opinion as to which DFMs they should embrace and work with.

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    According to Defaqto, the 2015 forecast for advisers’ use of DFM managed portfolio services (MPS) was £3.3bn of new money – a growth rate of an impressive 25.9 per cent.

    With more than 75 providers of MPS available, how do you begin to go about selecting the right ones for your clients? Most adviser firms will construct a small panel of DFMs, typically between three and six. In my opinion, it is important that these providers complement each other, rather than replicate what they do, so at least there is a chance they will not all perform in a similar fashion when the markets go up, or importantly – as is currently the case – when they go down.

    There are some excellent papers produced on the subject from various platforms, such as Nucleus, and research companies such as Defaqto, so there is no shortage of information and advice available, which should be the starting point for any adviser looking to outsource their investment requirements to a DFM offering an MPS.

    From the perspective of a DFM offering an MPS, I believe there are a number of important factors to consider, which are by no means exhaustive, but might at least be of assistance when starting out.

    First produce a long list of DFMs, somewhere in the order of 12 to 15 should do, that offer an MPS from which to begin your search. A simple ratings agency filter could help at this stage. A good starting point then is to request an up-to-date due diligence questionnaire (DDQ) from those companies that you believe have committed the time and, importantly, resource, behind their MPS resulting in an emphasis being placed on this side of their business by the management of the DFMs in question. Once you have reviewed the DDQs, the heavy lifting really begins.

    In my view, one of the most important considerations to have concerns the culture and management of the business you are researching. All too often this is overlooked, but if you are effectively going to work with a DFM you should understand all there is about the background of the provider. How strong is the business and how well-resourced are they? Do they have a reputable brand in the industry?

    Size is not everything, but it does give some comfort in an uncertain and volatile world and it demonstrates the ability of the management running the business and how it has performed during different economic cycles. There are many questions to be asked of the DFM before moving to the next stage, but once you are satisfied with the answers you receive you can then progress with more practical issues.