On average, 20 per cent of advice firm assets are now in some kind of external discretionary portfolio service, according to a survey of advisers conducted in February and March of this year by Research in Finance.
The motivations to outsource investment are well understood. It may be due to a lack of in-house resource or expertise; it may have more to do with reducing risk within the business. Or it could simply be to allow more focus on the bigger financial planning picture.
Whatever the motivation, selecting the right discretionary fund manager for clients is a critical decision for the advice business and carries huge risk if it’s a bad choice.
RSMR has been providing qualitative DFM reviews and ratings for advisers since 2017, as a logical extension of our fund ratings that we’ve provided since 2006. When evaluating a DFM we start from the top and work our way down. It’s a lengthy process but necessary in order for us to consider rating a given firm.
It’s also a process that advisers should be aware of when considering choosing or changing their discretionary management provider, or discussing their provider with clients. So in this first of three articles, we break the process down and bring it to life, starting from the top. Below are some of the key questions to consider.
Corporate structure & key personnel
- Ownership structure
What is the history of the company, when was it first founded?
Is the company listed?
What is the free float?
Who is the ultimate parent and who are the major shareholders?
Listed companies will have a more rigorous reporting and disclosure regime than a private limited company, making it easier to access key financial information. They may also have better access to capital markets to secure funding. Private firms may have more skin in the game when it comes to ownership, as senior management may well include original founders and practitioners. Lack of outside shareholders may also make it easier for them to take a longer-term view.
- Board structure & senior management
Whether listed or private, who are the people driving the company?
Board members’ bios; what’s their tenure with the firm, perhaps they’ve come up through the ranks, or come from a competitor?
- Governance
Is the firm practicing good corporate governance?
The boardroom sets the tone for the entire business and this is where the culture and values of the firm are shaped, which in turn influence the way the firm interacts with its stakeholders and the wider community.
Does the company have clear policies regarding ESG, and what commitments has it made in this respect?
How many non-execs are on the board and what is their background and experience?
What is the overall staff headcount and turnover rate? How has this increased/reduced over the years? Can they recruit and retain quality staff?
Now that we understand more about the ownership and management of the business, we turn our attention to their financial standing.
- Regulatory filings and accounts
Again, listed companies will have a little more transparency in this respect. Accounts would be viewed over several years to understand any emerging trends within the business.
What is the profitability of the business?
What is the trend in revenue and earnings over the years?
Where the DFM is part of a larger entity, what is the size of the revenue segment attributed to the DFM? And is that growing or shrinking?
What level of autonomy do they have?
Where is the capex focussed? Are they investing sufficiently in their people, systems, infrastructure, and client servicing functions?
How strong is the balance sheet, what is the outstanding debt and when will it mature/need refinancing?
Pillar 3 disclosures are now readily available for most companies, listed or not. Are they maintaining adequate regulatory capital? Looking at the trend in revenue and earnings is it likely they can continue to do so?
How is the business growing, organically, via acquisition or both and is it sustainable?
How do other ratings agencies view the firm? Is the debt rated by credit agencies and if so, what is the current rating for both the firm and outstanding issues and how has that evolved over time?
Statements from management in the annual reports reveal useful information as to where management want to take the business. What is their strategy for the business? Where are they focusing their attention and resources?
What risks to the business do management note?
Are there new product offerings on the horizon?
Are they developing their own D2C propositions?
What is the company’s history of compliance? Any past or pending issues with the regulator?
Are they committed to the adviser relationship? How have they invested in servicing this relationship? Do they have local offices and are they increasing or reducing this local presence?
Once we’ve looked at and exhaustively assessed all these areas and we’re happy with the structure, stability, and sustainability of the DFM business, we move on to the next part in our evaluation process. That will be detailed in the next article in this series.
David Perkins is a consultant at RSMR. Prior to his work on investment management, he owned and ran an IFA practice
