In our previous article we started at the top and looked at how we assess the corporate structure and quality of a DFM firm.
In this article we drill down into the DFM’s investment proposition, the philosophy and process and the mechanics by which this is delivered to underlying client portfolios. We also consider how robust the firm’s risk control and monitoring functions are.
Investment philosophy
Firstly, what is the overarching investment philosophy of the firm. How do they believe they can generate alpha and add value to client portfolios?
Is there a centralised investment committee which dictates a house view and asset allocation decisions across all of the firm’s offerings?
With most DFMs now offering a range of service propositions, it is important to ascertain if, and how, the same overarching investment philosophy is applied to all offerings. Assets which are held in a bespoke nominee account for example, may not be permissible on a retail platform hosting a model portfolio service.
What latitude do individual portfolio managers have to deviate from the central asset allocation and security selection guidance?
Committee structures
What are the various committees that contribute to the overall investment decisions?
Most DFMs operate some form of central investment committee which is typically led by the chief investment officer, with a number of sub committees reporting in, such as an asset allocation committee, stock and fund selection committees and so on. It is important to ascertain what role these committees play and the hierarchy and decision making processes employed.
Who sits on the various committees? What is their experience and what other roles do they perform within the firm?
Research
What is the extent and capability of the firm’s in-house research function?
How well are the various research departments resourced and staffed? Here it is worth looking at the biographies and experience of the senior people within the research divisions.
What external research resources does the firm utilise?
Is research cost absorbed on the firm’s own P&L?
How many company visits/manager meetings does the firm typically conduct on an annual basis?
What is the firm’s stance on ESG matters?
Do they offer sustainable/ethical branded portfolios and/or is ESG embedded within the research process?
Portfolio construction
What type of securities will the firm invest in? For example, will they hold direct equites and bonds or do they purely utilise collectives. This may differ between their bespoke services and their model portfolio solutions. Would they hold Ucis funds, hedge funds, or funds falling under AIFMD for example? Do they invest in structured products, unlisted assets or crypto currencies?
What is their stance on derivatives and hedging?
The best centralised investment proposition in the world will only work for your clients if it is reflected in their individual portfolios. It is, therefore, important to understand how the firm communicates the latest house views and tactical asset allocation calls to the various divisions that manage client assets. For one size fits all model portfolio solutions, this should be reasonably straightforward.
For the more bespoke solutions however, it becomes much more nuanced. In order to tailor portfolios to individual client needs, objectives, and any social or ethical concerns, portfolio managers need to have a degree of latitude by which they can deviate from the central process at the asset allocation level and particularly at the security level. Understanding the degree of latitude portfolio managers have and how this is monitored should form part of any due diligence process when selecting your DFM.
Benchmarking and performance
How will portfolios be benchmarked?
Are these benchmarks realistic given the asset mix within the portfolios?
How easy are they to compare with other portfolios your firm might offer?
Does the DFM submit their portfolios to Arc for peer group comparison?
What attribution analysis will be provided?
From a compliance perspective, advisers will need to ensure the selected portfolio matches their client’s attitude to risk.
Who will be responsible for risk profiling, adviser DFM, or both?
Has the DFM mapped their model portfolios to the adviser’s selected risk profiling tool?
Risk control & monitoring
Advances in technology and software systems have done much to aid the risk monitoring process, making trade and portfolio analysis instantly available to the various parties involved within a firm’s risk monitoring function. However, this will only be effective if the information is analysed correctly, in a timely manner and acted upon where necessary.
It is useful to have a broad understanding of the risk control policies of the firm. Where does the risk control and monitoring process begin? In the first instance this might be with portfolio managers themselves.
Moving up from the portfolio manager, what is the next line of defence? What teams/committees are in place to monitor portfolios? Here it is again worth looking at the bios and experience of the key members of the teams.
To whom do the various risk managers report and how independent are they from the investment team?
Are managers permitted to place their own trades, or is there a centralised dealing function?
How frequently are portfolios checked for mandate compliance?
Where portfolios drift outside of their mandate and the risk team identifies an issue, is there a clear policy, reporting line and timeframe on how this should be addressed?
What tools/software are employed to help with the monitoring process. Do these systems provide pre-trade alerts?
Who has access to these reports?
Finally, is there an external third party audit of the internal risk monitoring process?
In our final part in the series, we look at the relationship between adviser, client, and DFM and ask what levels of support and servicing an adviser might receive. Stay tuned….
David Perkins is a consultant at RSMR. Prior to his work on investment management, he owned and ran an IFA practice
