Outsourcing investment to a DFM service can make sense for IFA firms but they have to go into the relationship with their eyes wide open, says Harry Kerr
Whether a client is in the accumulation phase of their retirement plan or post retirement and taking income through an invested means such as drawdown, being able to effectively manage the client's investments is essential for the advisory firm.
The ongoing stock market volatility experienced since the financial crisis in 2008, including some quite dramatic falls has driven this message home. More than ever, clients want their investments to be managed to capture the upside and protect against the downside.
One increasingly popular trend is to outsource investment management to a discretionary fund management (DFM) service. The advantages of using a DFM have been well documented and include:
• the focus of full-time, well-resourced investment professionals to conduct whole-of-market research and run client money;
• the choice of bespoke and model portfolios; and
• the ability to quickly rebalance client investments when market events occur.
This frees up adviser time to focus more on the financial and tax planning for clients and building the client relationship.
However, it is essential when IFAs look to use a DFM service that they are aware of the potential pitfalls and so can manage the relationship in an effective manner.
Issues to consider
When outsourcing to a DFM there are important issues that advisers need to consider. Perhaps, the most significant is that in order for the fund manager to carry out the transactions necessary to run the portfolio, the conventional outsourced business model requires that the IFA signs over the client's assets to the DFM.
It is easy to see the dangers with this arrangement for adviser firms. Not only are they relinquishing control of a large part of their business but, significantly, a large part of the service to the client.
If the client places a high importance on the investment management this can create confusion as to where the true value of the service lies and who is delivering it - the IFA or the DFM?
The risk is that the client sees the greater service being delivered by the DFM not the adviser. As a result, it is not unknown for clients to move their business to the DFM, especially where the DFM operates their own advisory arm.
A further problem occurs should the DFM not deliver the expected performance and it becomes necessary to bring in a new firm to run the client portfolios. Since the assets are held by the DFM, issues can arise around having to sell and reinvest assets, not least due to the inherent trading costs and potential tax implications for the client.
One way for the adviser to stay in control of the assets, the relationship and the value proposition, is to run the DFM service via a nominee account on a wrap/platform.
The client's assets are held on the platform rather than being passed to the control of the DFM. The DFM transacts via the platform, including regular rebalancing/switching of investments for bespoke and model portfolios, but the IFA retains control of the assets and in consequence, the outsourced proposition.
In this way, the adviser keeps the relationship with the client, undertakes the financial and tax planning and, importantly, is seen by the client to be managing the investment process too.
When the IFA meets with the client for the annual review, using reports drawn from the DFM and the platform, the value of the IFA's role in managing the total service is clear to the client.
Importantly, this proposition aligns with the principles of the Retail Distribution Review, in particular in respect of providing measurable ongoing service, which is why it makes sense for IFAs considering the outsourcing of investment management to do so using a suitable platform.
Level of service
It is particularly important that the platform selected can provide the level of service required by the DFM, notably access to the full range of investments to effect the necessary tactical and strategic fund management. It will be of little use to a DFM if the platform chosen for them to work with is unable to support the full range of assets it needs to run either the bespoke or model portfolios.
It is equally important that the platform purchases institutional funds, so there is no initial charge and a lower annual management charge, and that it makes no transaction costs for switching/rebalancing of investments. This helps keep the cost of using a DFM to a minimum for the client.
Harry Kerr is managing director of Avalon.
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