InvestmentsJul 6 2017

Pros and cons of outsourcing investments

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Pros and cons of outsourcing investments

Therefore it is key to make sure there is proper due diligence carried out on the discretionary fund manager (DFM) itself.

This is not just a nice-to-have; it's a regulatory requirement and, as such, can be an onerous task to make sure that it is done right. 

One only has to think of the FCA’s thematic reviews of recent years. For example, in February 2016, the City Watchdog published TR16/1: Assessing suitability: Research and due diligence of products and services. 

According to the regulator, this was borne out of research into how well advisory firms researched the investment services before recommending them to clients.

Advisers should also consider whether the DFM is prepared to manage different portfolios within different tax wrappers, with different risk profiles. Peter Mullins

The thematic review stated: "We considered how they review the market and ensure they recommend suitable solutions for retail clients."

This included, for example, exploring how:

* Firms selected products, funds, platforms and discretionary investment management services.

* Firms created panels and centralised investment propositions (CIPs).

* Firms considered options for individual clients.

While the regulator found most advisory firms were doing a good job in terms of due diligence on third-party firms, others were lacking in their duty of care to the end client in this regard.

At the time, Linda Woodall, who was then the director of life insurance and financial advice at the FCA, said: “Research and due diligence is one of the three pillars of getting advice right, which is why we have returned to this issue. 

“Firms clearly want to get this right and all firms, regardless of size or type, can carry out good research and due diligence.

“However, there are still improvements firms need to make and we’d encourage all firms to look at our findings and ensure they are challenging themselves to ensure they’re delivering quality due diligence for their clients.”

For many advisers, fears they could be on the receiving end of regulatory enforcement if they do not fulfil their due diligence obligations could be considered a huge disincentive to outsourcing.

However, due diligence is vital to the ongoing relationship, as Rohit Narang, chief operating officer for Intelenet Global Services highlights: “Advisers need to know the [firm to which they outsource] is financially stable and will be a reliable partner.”

Due diligence is also a necessary burden in order to protect clients in the event of anything going wrong with the firm to which advisers have outsourced.

The importance of checking and double-checking was underscored last year, when the FCA removed the permissions of one DFM, Analyst Investment Management Plc.

In August 2016, Analyst was found to have “failed to pay fees and levies to the FCA, despite repeated FCA requests that it do so”. The note can be found on the FCA register of companies.

At a glance: what should be on the adviser's checklist when outsourcing?

  • How well does the DFM integrate with your platform?
  • What accreditations does the DFM have?
  • What do existing clients say about the DFM?
  • How does the solution support your clients?
  • How flexible is the DFM?
  • Has it provided a due diligence pack?
  • What is the firm’s core business, culture and values?
  • What is the investment process?
  • What sort of risk-rated models are used?
  • What support do they offer intermediaries?
  • Will they provide value for money through technology investment?
  • Although it is no indicator of future performance, what is the historic investment process and performance related to that strategy?

Client poaching

Another potential down-vote for outsourcing is the lack of control that an adviser might have over how clients’ money is being invested, or even over the client relationship once they outsource.

In 2015, Emma Wall, editor of Morningstar, told FTAdviser that advisers who use a bespoke service provided by a DFM that also employs financial planners could face “some risk” of poaching as the client will have a direct relationship with an investment manager at the DFM firm.

However, contributors to this guide believe it is unlikely a DFM would seek to steal or consolidate clients, believing the process of advice and the process of investment management are best done by the experts.

Peter Mullins, head of business development at European Wealth, says: “The relationship of the DFM with both the adviser and the client is crucial. If the relationship is a good one, the adviser should not feel threatened if the DFM has direct and regular contact with the client.

“In fact, that should be encouraged as we are in a relationship-driven business. Some DFMs have little personal contact with the client, while others encourage it.”

It all comes down to how respectful the DFM is of the client-adviser relationship. Emily Booth, senior investment manager for Parmenion Asset Management, comments: “The adviser owns the client. When they choose to work with us, advisers can dictate the level of control they want to maintain.”

Cost to client

As mentioned in a previous article in this guide, cost can be a factor, if the end client has to pay for platform fees, MPS fees, advisory fees and any other associated costs, such as interim trading expenses like stamp duty. 

This is why, according to Mr Mullins, advisers should put a focus on cost high on the list of things to consider before outsourcing.

He says: “Advisers should look at the total DFM’s fees and how they are charged. For example, some use a sliding scale depending on the size of the portfolio, while others will be a set amount, but other charges may apply, such as dealing fees and the ongoing management fee. 

If advisers have an issue, it is important they know there will be someone whom they can talk to. Mickey Morrissey

“Also check whether these fees are compatible with the fees charged by the adviser, and how these compare with those of other DFMs.”

Size matters

Also, some DFMs are not prepared to take on low-value clients, so Mr Mullins comments that advisers should ask what are the minimum sizes of portfolios that the DFM is prepared to manage.

He adds: “Advisers should also consider whether the DFM is prepared to manage different portfolios within different tax wrappers, with different risk profiles.”

Plus points

For Ms Booth, there are many good reasons why advisers would want to outsource the investment process so they do not have to do the “heavy lifting”. 

She says: “Advisers picking funds or using advisory model portfolios have their time constrained achieving consent with less engaged clients, see portfolio drift in their assets under management (AUM) and need to reflect all these aspects in their professional indemnity declarations.

“A discretionary approach will achieve the desired client outcomes, without ongoing adviser administration but the responsibility for setting the mandate, of course, remains with the adviser.”

Cost-efficiency for the adviser

Advisers spending less time picking stocks and more time working with clients will be able to grow and enhance their business, according to Mickey Morrissey, head of distribution for Smith and Williamson.

This means the adviser has more time to do the necessary financial planning as well as focus on attracting and retaining new clients, which is essential for the financial health of the firm.

Moreover, there is a cost efficiency built into the process for the financial adviser who outsources, rather than manages investments in-house.

Mr Morrissey explains: “Outsourcing using an MPS can save advisers money on the underlying costs of collectives, because [DFM] firms will have the buying power to be able to buy cheaper share classes.”

Support

The investment process is key, but other important aspects to consider are the technological and business support that outsourcing can provide to the adviser.

Mr Narang of Intelenet Global Services, comments: “A provider can take on the cost associated with technology investment. 

“It is therefore important they give value for money through providing cutting-edge services and solutions. Alongside this tech expertise is cyber security, as it is essential that the client data is in safe hands.”

Advisers without the financial or technical resource to implement such systems could benefit from the operational support of the DFM provider who may well have deeper pockets.

Moreover, as Mr Morrissey adds, the DFM should be able to provide other support to advisers. 

“It is worth looking at what they offer intermediaries across sales, operations and marketing.

“If advisers have an issue, it is important they know there will be someone whom they can talk to.”

simoney.kyriakou@ft.com