Operational burdens and obligations of discretionary permissions

If a firm chooses to hold its own permissions, it will first need to make sure its advisers hold the relevant qualifications to offer a discretionary service. 

It can then apply for a variation of permissions from the Financial Conduct Authority. 

For those prepared to undertake this activity, it can be quite an onerous process, involving submitting a detailed business plan and financial forecasts. 

Once approved, the firm will need to comply with additional capital adequacy and ongoing regulatory reporting requirements.

But for those who want to outsource, while it is meant to create efficiencies, it also requires a monitoring of the DFM programme.

Robert Vaudry, managing director of Copia Capital, says outsourcing to a DFM is more straightforward as it will already meet all the necessary regulatory requirements. 

“But to really reap the benefits, it’s important that you select the right partner,” he adds. “One that provides specialist investment management to reliably de-risk your investment activities without requiring high levels of operational input from you.”

Outsourcing introduces an extra set of resources to the business, with clear cost savings to the advice firm as a result.Robert Vaudry, Copia Capital

Vaudry says advisers who outsource their centralised investment proposition to a DFM should see a clear reduction in time spent on monitoring, managing and reporting – and operational and business risk will also fall. 

He adds: “Whether you run your investments in-house or outsource to an external manager, you will remain responsible for designing your CIP, implementing it across the business, and the overall advice given to the clients. 

“However, outsourcing introduces an extra set of resources to the business, with clear cost savings to the advice firm as a result.”

Outsourcing to a DFM is a very effective route. Most DFMs are on at least one of the major platforms or have a direct option. 

Lewis Hamm, chief executive of O-IM, says the technology has improved in recent years so there is effective integration with both back office and client-facing technology. 

Additionally, Hamm says the effort for an adviser is in getting to know the investment managers and understanding the investment process. 

He adds: “While holding their own permissions may simplify the investment process, the overhead and associated cost of effectively running a discretionary portfolio is very unlikely to improve the client outcome.”

MPS

Among the factors advisers should consider when picking a DFM is proven pedigree, says Tony Lawrence, senior investment manager at 7IM.

“It is pretty easy for DFMs to launch a model portfolio service,” Lawrence adds. “If you compare it to, say, launching a multi-asset fund for example, this is much harder to do, as you typically need money to be invested from day one. You require a prospectus that is subject to regulatory approval, you possibly need to subsidise the running costs, and need to appoint various counterparties like fund accountants, transfer agents and a depositary.”

A number of these counterparties also have fiduciary duties to provide checks and balances, so there needs to be compliance and risk teams, as well as appropriate governance structures to support this internally. 

“None of this is legally required for an MPS, but we would argue the robustness from this more institutional structure and resourcing provides much greater assurance that there will not be issues further down the line, offering some comfort that clients will experience outcomes in line with expectation,” Lawrence says.

“The advisers’ reputation will become interlinked with that of the DFM when partnering with them, so mitigating this risk is important from that angle too.”

Lawrence also says asking questions about the investment process underlying the service and support offered by the DFM, particularly in tough economic times, is also a key metric advisers should look at.

ESG

As environmental, societal and governance investing becomes more prevalent, this is an area with increasing consumer awareness and demand, and with imminent regulation regarding ESG suitability on the horizon.

Advisers selecting a DFM should ensure the DFM’s capabilities and experiences are aligned with this direction of travel. 

Hamm says ESG is an area that is still developing, but many DFMs will inevitably struggle here because their models principally use funds and so the reliance is on the DFMs knowledge of the fund manager and their ESG screening versus [factors such as] standard metrics like fees, performance, volatility.

“Advisers should be pressing DFMs on how they tackle and consider greenwashing and what exists in their investment process to challenge the funds,” he adds. 

“The alternative approach is to find a DFM who allocates to direct equities as then the DFM would have assessed the individual company and its ESG credentials, so will be far better placed to engage with the adviser and give them the necessary level of comfort.”

According to Craig Wright, managing director at Evelyn Partners, IFAs should meet the fund manager at least quarterly or attend updates and document the outcomes learned on a regular basis. 

Regular updates should cover risk, returns, rebalances and reasons why investment decisions have been made.

Advisers should be pressing DFMs on how they tackle and consider greenwashing.Lewis Hamm, O-IM

Mike Morrow, chief commercial officer at Parmenion, says for an adviser to hold their own permissions, they need to meet a number of regulatory requirements, including:

• Proving their firm has the appropriate investment skills and capabilities.
• Proving their firm has the right infrastructure and processes.
• Proving their firm has the right oversight and governance.
• Provision of regulatory capital.
• Understanding the impact on costs such as professional indemnity.

Overall, the adviser firm will need to be confident that securing their own permissions is worth the cost and risk, which is why it is often only something that firms at scale consider.

If a firm is outsourcing to a DFM, the adviser should be confident that the DFM can demonstrate the following:

• A clear investment philosophy and robust investment process.
• A track record of consistent, cost-effective, risk-adjusted returns in different market conditions.
• Strong capabilities, governance and oversight.
• Good relationship management and great communications – particularly in challenging or volatile markets.
• Good support for the adviser in terms of expertise and collateral.
• Financial resilience.

Morrow adds: “Outsourcing also gives the adviser firm the option to procure different DFM solutions for different client needs, and to change/switch out DFMs if the service is no longer meeting the standard required, or client needs change.”

Ima Jackson-Obot is deputy features editor at FTAdviser