What are the benefits of outsourcing to a DFM?

This is why, according to Mike Morrow, chief commercial officer at Parmenion, most adviser firms wanting to build the efficiency of discretionary models into their process will choose to outsource.

Morrow says: “Outsourcing to a DFM brings many benefits: reduction in cost and risk to the adviser firm; the ability to diversify across investment styles and philosophies to deliver appropriate client outcomes; and being able to concentrate on financial planning for clients.  

“It also means the adviser can hold outsourced DFMs to account for investment performance and decouple that from the firm’s reputation and their client relationships.”

He says outsourcing to a DFM also enables tighter control of client outcomes because discretion ensures clients are in a defined model or mandate aligned to the advice. 

“It reduces risk of poor client outcomes caused by multiple clients in multiple versions of models under advisory permissions. It ensures appropriate investment expertise and oversight, without the need to have this capability in the adviser firm, reducing both costs and risks,” Morrow adds.  

“It also creates administrative efficiencies in firms who no longer need to secure client signatures and/or permission to change models or negotiate reasoning for changes, especially at times of stress. 

“Advisers can identify DFMs with the right specialisms to best serve their clients, particularly around ESG.”

A study by DFM Copia Capital, carried out into centralised investment propositions, found that while having their own discretionary permissions originally drove efficiencies in advice firms, the additional administration and regulatory burdens of Mifid II have made them more time-consuming to operate.

Portfolio changes like rebalancing or fund switches require authorisation from every client invested in the portfolio, meanwhile it has been predicted the requirements of the consumer duty are likely to make things worse.

Robert Vaudry, managing director of Copia Capital, says: “While obtaining advisory permissions will make some of the CIP administration more straightforward by removing the need for individual authorisation to make portfolio changes, outsourcing to the right DFM provides access to the research and resources of a specialist investment manager focused on managing the client’s money in line with the agreed mandate from the adviser.”

The regulatory footprint for the adviser is also much reduced, with the DFM picking up the bulk of requirements for due diligence.Tony Lawrence, 7IM

Research from Copia also found that outsourcing to a DFM reduces operational and business risk. Copia found that outsourcing to a DFM led to a 25 per cent reduction in time spent monitoring the CIP, a 72 per cent reduction in maintenance activities and a 30 per drop in reporting, compared to firms running their CIP in-house.

Lewis Hamm, chief executive of investment management firm O-IM, says that one benefit of an adviser outsourcing to a DFM is that it eliminates conflict for the adviser.

Hamm adds: “The adviser can pick the best solution for their client from the approximately 100 DFMs who actively distribute their models via the major platforms. 

“By not having discretionary permission an adviser’s primary focus is financial planning for their client versus the demanding responsibility of having discretionary permissions, eg investment selection, asset allocation, additional reporting and regulatory oversight.”

Tony Lawrence, senior investment manager at 7IM, says discretionary permissions also allow changes to be made without requiring consent from clients. 

He adds: “Trying to manage portfolios on an advisory only basis is much more problematic when trying to make changes, often resulting in clients experiencing drift or having ‘stale’ portfolios and vast differences from client to client – a big issue when trying to deliver consistent client outcomes.

“Additionally, there are many other attractive features of outsourcing. The operational burden is vastly reduced, with the DFM taking on all the strain of updating the models, often across multiple platforms. 

“The regulatory footprint for the adviser is also much reduced, with the DFM picking up the bulk of requirements for due diligence, record-keeping and governance around the selection of individual positions.” 

Considerations

When it comes to picking a DFM, there are a variety of factors an adviser should consider.

It goes without saying that good service would come top of the list.

Morrow says the DFM should offer reliable access to investment outcomes, have good relationship management to support the adviser with their client relationships and provide great communications for both adviser and client – through both good and challenging markets.  

They should have a clear philosophy and consistency of process and performance, meaning they have the ability to help advisers understand what the customer is paying for and whether it is of good value. Additionally, the DFM should be able to help advisers coach their clients to understand what will happen to their portfolios in volatile markets.

According to Vaudry, there are some further considerations an adviser needs to make when looking for a DFM:

• Is it whole of market? Not putting in their own funds? 
• What is the business risk (B2B or B2C)? 
• Does it operate a reliance on others or an agent as client model? 
• Does it help advisers manage key people risk? 
• Does it have strong fund manager knowledge? 
• What risk management tools does it have? 
• How does its pricing compare with DIY? 
• Is the adviser’s custom provider platform-agnostic? 
• What support does it provide for the continuity of the adviser business? 
• Does it offer scale advantage in terms of institutional-level pricing and access? 

Hamm says each client may be suited to a different DFM based on what is important to them. 

For example, a client who wants an Aim portfolio to help manage their potential inheritance tax liability will need to find the DFM who can select individual companies, provide detailed insight into those companies but not charge an inordinate fee for it. 

He adds: “Another client may feel strongly about ethical investments and the adviser will need to search out a DFM that best manages the risk of greenwashing and can meaningfully engage the client with that investment portfolio so the client is confident those ethical considerations are sufficiently met.”

Ima Jackson-Obot is deputy features editor at FTAdviser