Discretionary fund managers - an integral part of the investment process or the road to ruin? Laura Miller investigates
It seems never a week goes by without the Financial Conduct Authority (FCA) raising a warning flag about something.
Most recently, the regulator has turned its attention to investment outsourcing.
Relying on the marketing material from discretionary fund managers (DFMs) or other authorised firms was "not acting professionally and in the interest of the client", technical specialist for the regulator Rory Percival said, though relying on facts is allowed.
With the regulatory spotlight swinging in DFMs' direction, are they the latest risk area for firms?
Percival added that the FCA expected firms to be "broadly competent" in the areas they have outsourced a function in, so that when they see the outcomes they can give it a "sense check". "You can't outsource responsibility," he said.
Sense and sensibility
Advisers' use of DFMs is not new, but with the regulatory spotlight shining in this direction, are they the latest risk area for firms?
Key to this is the following question: what does a "sense check" for a DFM look like? The FCA, unsurprisingly, does not say.
Advisers, however, have their own ideas, though given FCA scrutiny of the area some are so nervous about putting their head above the parapet that they would only comment about it anonymously.
One such adviser who wanted to remain nameless only uses DFMs for clients with assets in excess of £250,000, though in reality the bulk of his firm's DFM business is with those who have assets in excess of £500,000.
As someone who juggles Brewin Dolphin, Brooks Macdonald, Deutsche and Vestra, in addition to the firm's own DFM offering, he has investigated a big chunk of the sector, and he likes to keep his DFMs close.
"Don't be afraid to involve the DFM in the client meetings. Some IFAs feel this is a sign that they are not on control of the relationship and the DFM will be seen as the main value-add in the relationship – this is definitely not the case."
He believes using a DFM allows the IFA to concentrate on the wider advice and the overall financial review.
"Let the DFM tell the investment story," he recommends.
Astute Wealth Management financial planner Angelo Kornecki uses Seven Investment Management and Brewin Dolphin.
He tackles the question of DFM due diligence with an internal investment committee, which meets at least once a quarter, where prospective DFMs have the chance to demonstrate they can meet his firm's long list of expectations.
These include good historic performance against their anticipated returns and benchmarks, a robust, repeatable investment process, a wide range of investment structures and tax wrappers, and the ability to talk directly to the fund manager and involve them in client meetings.
He warns of the dangers of not following this path.
"I think it is incredibly important to perform as much detailed due diligence as possible as a solid client relationship that has taken years to build can be damaged very quickly if you refer to a poor DFM.
"I want to know how they measure performance. They must understand the concepts of good financial planning, and have access to a good platform for ourselves to buy and sell funds and also for our clients to engage in their own investment strategy."
Kornecki also believes it is very important that a DFM has simple, clear, transparent and competitive fees.
Fees are the reason Capital Asset Management chief executive Alan Smith will not touch DFMs.
"Once all the costs of management, trading, dealing and spreads and tax are taken into account, the cost of most DFMs is more than 3% a year.
"As a consequence, most underperform their benchmark index and for those reasons we don't use DFMs," he said.
Smith's point is a pertinent one. Advisers who, post-Retail Distribution Review, already have to have a 'fees chat' with clients, may baulk at adding to this with a DFM cost discussion, especially as this choice now comes with added FCA scrutiny.
So what is the verdict on DFM use? Proceed by all means – but with caution.
For those who do decide – fees taken into account – that DFMs offer a good investment solution, the message is clear; make sure you undertake rigorous and demonstrable due diligence to select the ones best suited for your clients in order to avoid difficult questions from the regulator.
Fund managers can expect the axe from DFMs if they fail to perform within the first 12 months of being granted a mandate, according to research by Coredata.
DFMs, on average, tolerate just ten months of underperformance before replacing a manager, while half of DFMs say they would replace a fund manager who has underperformed for only six months.
Did you know?
Almost half of DFMs typically involve less than five people in the process of selecting a new manager
A third (29%) of DFMs admit to taking more than three months to award a new mandate to an asset manager they have had no past dealings with
EIS and Seed EIS sectors
'Truly making a difference'
Avoidance, evasion and non-compliance
From 6 April 2019