InvestmentsJun 26 2018

Putting the world of DFMs to rights

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Putting the world of DFMs to rights

This is particularly true in the discretionary fund management (DFM) space, where providers have been striving to offer a wider range of propositions, including more niche products, in response to industry shifts. 

“We are getting more segregation in the market itself, so you need to have the offerings in place,” Simon Cooper, head of business development at Cazenove’s DFM team, told advisers at a Money Management breakfast briefing last month. “Advisers [previously] wanted us for bespoke, but now they want us for the whole client suite. They want us from £1,000 upwards.”

Specialist offerings, such as tax-focused portfolios, have also been an area of interest. Some in the wealth space have launched products focusing on the Aim  market, in part due to tax considerations, as well as inheritance tax offerings. But as the range of products on offer becomes more diverse, bespoke portfolios are starting to fall into line with their more standardised peers in one particular aspect.

Mr Cooper added: “Some risk-rating companies are looking at rating our bespoke portfolios, which I think is a good thing. There are some that won’t be too relevant, but we are trying to find a way. That’s where tech is playing a large part, because our data feeds from our back office [are improving].”

Kerry Nelson, managing director at Nexus IFA, said the firm measured its own bespoke portfolios along these lines, but acknowledged that doing so could be “hard” given the idiosyncratic nature of individual portfolios. Such developments underline the delicate balancing act of addressing clients’ specific needs while maintaining the ability to manage money across the business.

Ms Nelson said: “You will have the mainstream solutions and then a small minority [of clients] that go off piste. The point of having things streamlined is for the efficiency of the business, otherwise you end up compromising too much and that has a snowball effect.”

Many assert the proliferation of different services represents a positive development, because it will prevent clients from using the wrong products.

“The thing about choice is you can avoid shoehorning,” Fraser Donaldson, of research provider Defaqto, explained. “You can look at DFM portfolios almost like funds and say, ‘I want the best risk-rated five [portfolios]’.”

Some advisers have grown concerned about funds moving between different risk grades, but Mr Cooper said the likes of the “traffic light” early warning system operated by Distribution Technology should provide reassurance that there would not be dramatic movements between ratings. “We try not to make portfolios drop in and out of different numbers, but we run money the way we want. And so far we have been slap bang in the middle of the ranges,” he said.

Multiplicity

DFMs and the services they offer have multiplied in recent years, in part because of the demand triggered by the RDR. Defaqto now covers more than 100 discretionary firms and 1,450 model portfolio service (MPS) options.

With intermediaries increasingly segregating different clients – something now required under Mifid II rules – this at least means they can be grouped by level of assets. But an individual’s preferences still play a role.

“Every adviser is different,” noted Mr Cooper. “We have got people who have £1m-plus clients with MPS. Others have £150,000 and want bespoke.”

Robert Saunders, an adviser at Foster Denovo, agreed that while minimum investment levels for bespoke offerings were likely to rise further, some clients with relatively small sums would still prefer a premium service.

“It’s going to be [products such as] MPS from £200,000 to £500,000,” he said. “From £1m we get to direct equities and it can be bespoke. That’s the point at which a DFM starts to add value because funds tend to add costs there.

“Some people want to pay more money, which is their privilege.”

Growth areas

Developments in the DFM space reflect the client needs that have occupied intermediaries in recent years. In terms of dedicated structures, Mr Donaldson noted that Defaqto now covered 200 income-focused portfolios and 150 passive vehicles.

Another growth area has come in the form of ethical offerings. Defaqto covers nearly 100 portfolios with this focus, though many are run by one provider, Parmenion. But questions remain over whether such products have gathered sufficient momentum just yet. The current state of progress here can be seen in the fund space. Ethical funds held nearly £16bn of assets in April, but this only represented 1.3 per cent of the industry total, and is only slightly higher than the 1.2 per cent share recorded in 2008.

The event also addressed the behaviour of intermediaries when it comes to assuming, or outsourcing, investment responsibilities, and the arguments for and against using a DFM.

Outsourced investment propositions enjoyed significant growth in the wake of RDR implementation, but more recently there have been signs of a slowdown. The establishment of industry body DFM Alliance by five of the biggest discretionary names last year, aimed at pitching the benefits of outsourcing to intermediaries, was viewed in some quarters as a sign that growth has less momentum than it once did.

Similarly, there have been suggestions of advisers assuming discretionary responsibilities themselves. This could be a way of justifying adviser fees, cutting charges for the end client, or even preparing a business for sale.

“People looking to sell in a few years’ time will want to take the investment business back in-house, because that’s where the money is,” explained Mr Saunders.

Wake-up call

In its latest DFM service review, Defaqto found the proportion of respondents using advisory portfolios had jumped from 24 per cent in 2016 to 38 per cent in 2017, at the expense of discretionary offerings, and described this as a “wake-up call” for investment specialists. 

The firm suggested several possible causes for the move, including cost pressure, advisers regaining confidence in their ability to run money, and an enhanced level of competition from asset managers selling multi-asset funds. Respondents to the study also seemed less satisfied with DFMs than in previous years.

At the same time, dealing with major pieces of regulation, notably Mifid II, has increased the workload for discretionary firms.

In this context, some present at the roundtable expressed concerns over transparency. Peter Sudlow, principal of Sapienter Wealth Management, said he had found requesting transaction costs from other DFMs “really difficult” in the aftermath of Mifid II requirements that demand these charges be disclosed to clients.

Mr Donaldson said some DFMs did not believe they had to provide such costs until 2019, when the first year of post-Mifid II annual reports are due. “We are getting answers on transaction costs from around 50 per cent of DFMs,” he said. 

“Some don’t think they have to do it until 2019...I’m not sure why...but discretionary managers, we know, are having trouble getting transaction costs from fund managers for the underlying funds. If I am really optimistic, I would say the problem would be solved in January 2019, but we’ll see.”

Equally, advisers who choose to go down the discretionary route for some of their client base face extra logistical and regulatory burdens. Gaining DFM permissions takes time and effort, and can test adviser balance sheets.

“I’m not DFM-regulated, but I’m qualified,” Ms Nelson added. “It’s a balance around capital adequacy [and related issues].”

Money Management will explore these issues in more detail next month.