Figures suggest the share of businesses that run discretionary models is small, but growing. One in five members of the Personal Finance Society (22 per cent) said their financial advice business held discretionary permissions, according to a survey of 278 members last year, up from 15 per cent in 2020.
Advisory management can mean more engagement with clients, while oft-cited benefits of outsourcing to a DFM include enabling advisers to focus more on financial planning and their client relationships.
But obtaining discretionary permissions can bring benefits, too.
We can leave a holding almost that day for all of our clients, whereas having to get written consent from clients can take months.Haydn Brooks, Lathe & CoHaydn Brooks, a director at Lathe & Co, which received its DFM permissions last autumn, says the business can now be more proactive if there is geopolitical tension, a manager changes their style or a team leaves an investment house.
This was not the case before, as Brooks recalls when the business had its own portfolios that it constructed in 2018 alongside an investment consultancy. “We were running them on an advisory-only basis for two years, which was quite a cumbersome process.
“Every time you want to make a change to the portfolio, if you want to rebalance, you need to get written permission from clients, which wouldn’t have been a problem if we looked after a dozen clients.
“But as a business we look after more than that, so it started to be a bit of a pain if we wanted to make any changes. So it naturally led to getting our permissions.”
Indeed, Brooks describes rebalances that involved seeking written permission from 1,200 clients each time. “70 per cent of clients come back to you straight away, and then we ended up spending three months trying to chase 30 per cent of our clients for that authority.
“We ended up having a bit of client drift. There were a handful of clients who were in the old portfolios.”
The application process
John Long, head of discretionary investment management sales at Threesixty Services, a compliance and business support provider, likewise says that advice businesses should first consider their client base to assess whether they would benefit from access to an in-house discretionary investment management (DIM) service.
“Adviser firms that do decide they want to provide their own DIM service should then consider the corporate structure they want to adopt. Firms can either apply for a variation of permissions to the adviser firm’s existing regulatory permissions, or establish a new company to provide the service.
“If the new investment management service is purely for the use of the adviser firm’s own clients, then a variation of permissions may be the most logical way forward. If the plan is to market the service to the clients of other financial advisers, setting up a new company may make more sense.
The FCA is likely to look closely at what knowledge and experience is held.Graham Cross, Helm Godfrey“Either way the Financial Conduct Authority permissions application process is very similar, although marginally more straightforward for a variation of permissions.”
The application process involves submitting financial forecasts, as well as a detailed business plan. The latter needs to clearly demonstrate that careful consideration has gone into the company's business proposition, Long adds, including:
- Why the permissions are being sought;
- How the business will be managed;
- How the business will deliver good outcomes to clients; and
- Why it will be a profitable business.
From the date of submission to authorisation, Long says the process takes about six months, although this can vary. Indeed, Brooks says it took around a year for the Lathe & Co to receive its authority.
Extra regulatory responsibilities
Discretionary permissions enable investments to be managed proactively and efficiently but there are potential downsides, to which Brooks says his business is currently sensitive after recently gaining its permissions, and cites quarterly updates to the FCA's RegData as one example.
Long agrees that an advice business providing its own investment management service can bring efficiencies when managing client portfolios, and that the “substantial” regulatory obligations include a more demanding regulatory reporting regime, as well as a significant capital adequacy requirement.
The base capital adequacy requirement for a business looking to become a DIM is the higher of £75,000 or a quarter of its annual fixed overheads.
Businesses are also required to assess whether any additional capital or liquid assets are required as part of their internal capital and risk assessment process, with the FCA typically not accepting the argument that additional capital need not be held, explains Long.
“These things will divert time and resources from other activities that may be more effective at growing your financial planning business,” he notes.
Requirements on staff
Meanwhile at Lathe & Co, research is outsourced to investment consultancy Redington, rather than being undertaken by in-house analysts, while the business’s advisers already had the appropriate qualifications to offer a discretionary service.
“We had to pad out our compliance and operations teams, so we’ve got two new members who help us with the additional work and responsibility,” says Brooks. “All of the research and the monitoring of the portfolios is outsourced to Redington, and we speak to them on a daily basis.
“But then we have formal quarterly committee meetings where we take a deeper dive into the portfolios and make sure how we’re constructing the portfolios is right for our clients.”
Graham Cross, managing director at Helm Godfrey, which also launched a DFM service more than four years ago, says its advisers sit on the investment committee to help investment managers better understand what is important to clients, rather than taking a “purely academic” approach.
If care is not taken with this issue, there is a risk the regulator could challenge firms that only recommend their in-house solution.John Long, Threesixty ServicesIndividuals who will be involved in managing investments will require an appropriate qualification, says Long, such as the CFA’s Certificate in Investment Management, or the combination of the CII’s Financial Services, Regulation and Ethics (R01) and Discretionary Investment Management (J10) units.
“Our view is there should be at least two individuals within the business holding the appropriate qualifications. If decisions are being made by an investment committee, we suggest that the decision makers or voting members have the appropriate qualifications too.
“The FCA is likely to look closely at what knowledge and experience is held, especially if this will be the first time that those involved are undertaking DIM activities. You should therefore look to ensure that the business plan covers this aspect.
“My view is that this experience does not necessarily have to have been obtained in a DIM role. It could have been obtained in an advisory investment role but is transferable to a DIM role.”
Keeping clients’ options open
When assessing whether to launch an in-house DIM service, Long also urges businesses to consider how recommending such a service would work in light of rules on independence.
“If care is not taken with this issue, there is a risk the regulator could challenge firms that only recommend their in-house solution or that of an associated firm,” says Long.
“Independent financial planners must ensure they recommend services that are the most suitable for their clients’ requirements from across the market, whether they are provided in-house or externally.”
I think DFM permissions are really important, so we can create something quite unique for our clients.Haydn Brooks, Lathe & CoBefore launching its DFM service, Cross says Helm Godfrey had been running advisory models for more than 12 years, as well as outsourcing to third-party DFMs.
“A discretionary solution such as ours that offers active, passive and responsible models gives advisers a range of solutions that are likely to be suitable for most clients.
“We have retained the advisory models, recognising that some clients prefer to be engaged in the investment selection process rather than leaving it to a DFM. As an IFA, we still use other DFM firms when appropriate.”
Long concludes that the extra resource, skill and experience that is required for a business to provide its own investment management service, and focusing on developing these resources, will be a good way forward for probably only a small percentage of financial planning companies.
While Brooks says that discretionary permissions were not part of the initial plan when Lathe & Co was founded, he highlights their role in future-proofing the business.
“Being the company we want to become in the future, I think DFM permissions are really important, so we can create something quite unique for our clients.”
Chloe Cheung is a senior features writer at FTAdviser
