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Using third-party discretionary services can add real value to an advice business

  • By Jason Stockwell

How can you ensure that you are selecting the ‘right’ Discretionary Fund Managers (DFMs) for your business and clients? And what can you do to ensure long-term, successful partnerships? Abbie Knight of DISCUS takes a practical look at some of the issues involved


Over the past decade there has been an explosion in the use of third-party discretionary fund management (DFM) services by advisers. Today, approximately 50% of advisers embrace this approach and many expect that this will reach 60-70% in the next few years. If you currently use discretionary services, or plan to do so, read on for guidance to help you select, appoint and successfully deploy DFM in your business.

Discretionary management used to be the preserve of only the very wealthy investor. High minimums, fully bespoke portfolios and exclusive service to match, meant that only those clients of advisers with very large portfolios would be deemed appropriate for this service.

How times have changed. Since the start of this century DFMs have been using technology to drive economies of scale. This has led to the opening of this once out-of-reach service to a broader array of clients, thereby reducing its exclusivity. At DISCUS we welcome this trend and view it as cause for celebration.

Fifty shades of DFM

At the last count, there were more than 200 discretionary fund managers, each with a range of propositions on offer. If you are an adviser (or paraplanner), looking to filter this down to a panel of managers which you believe are best placed to meet the needs of your clients, where could you begin?

Any process should start with a solid understanding of the services on offer, including the key features, benefits and any perceived limitations.

In the broadest sense, DFM services include:

» Bespoke portfolios.
Here the service is tailored to the requirements of each client and might include access to specialist investments, fund exclusions and capital gains tax liability management. This level of personalisation comes at a price, which translates into high investment minimums.

» Managed Portfolio Services (MPS).
These portfolios are pre-defined to match specific risk or return objectives. The adviser and client are responsible for deciding the option best suited to their needs. A third-party investment platform may or may not be used.

» Discretionary Funds (or Unitised DFM).
Essentially a managed portfolio service wrapped in a collective structure (unit trust or OEIC). The funds can be unitised multi-manager or multi-asset and tend to mirror the methodology, philosophy and approach of the discretionary manager’s MPS. Operating as a fund, they do not offer the personalised approach of your typical discretionary service. A key benefit of the unitised structure is that the client is not subject to CGT unless they sell all or part of the fund.

DFM selection: start with the client in mind

The Product Intervention and Governance Sourcebook (PROD) introduced earlier this year has made it a regulatory requirement for all firms, not just product providers, to align products and services to their client segments.

This means that the traditional adviser approach of deploying DFM across an entire client bank, segmenting it based on asset size – for example multi-manager or multi-asset for clients with smaller portfolios, MPS on platform for mid-tier clients and ‘full-fat’ bespoke portfolios at the very top end – will no longer suffice.

Advisers now must group clients into segments and sub-segments linked to life stage, occupation, retirement status and other factors. These segments are then mapped to appropriate solutions from an investment, platform and advisory service perspective. For example, consider ‘young accumulators’:

Segment Sub-segment Investment
Young Accumulators Senior Executives Bespoke discretionary
Simple needs Managed Fund or MPS
Platform Advisory Service
DFM dependent Standard
Simple and low cost Light touch

These two sub-segments have very different needs and therefore warrant distinctly different solutions, right across the value chain. Advisers have to play this out across their entire business and consider where different approaches like active, passive, target return, low-cost, ethical or impact, growth and income will best ‘fit’ with specific client needs. This supports the creation of a long list of possible providers and solutions.

Stripping it back

It’s important to remember that DFM is a service and not a product, so advisers do not have to review the ‘whole of the market’ to remain independent. Best practice is to consider a wide range of providers and propositions – about 20 will do for your long list – in line with the predefined customer requirements.

The next stage involves looking at each one in greater detail and deciding who should remain in scope or be filtered out, to create a shortlist. Detailed notes from any meetings or information from trusted third parties should be maintained, creating an audit trail to support the decision-making process.

Successful due diligence

Rather than simply ticking a box for the regulator, I think due diligence should be viewed as a process that can add value to a business. By flipping your perspective, instead of a seeing it as a cumbersome and time-consuming task, due diligence becomes a valuable investment of time and resource to mitigate business risk.

The Financial Conduct Authority’s (FCA) guidance states not to rely on DFM marketing materials as the sole source of due diligence. This information should sit alongside other third party research and notes from in-depth questioning undertaken via Requests for Information (RFIs) or in-person meetings.

We have a wealth of resources on our website (discus.org.uk), including a helpful due diligence audit. Simply type ‘due diligence’ into the search function and the content will appear. A few points worth noting are:

1. Suitability and risk mapping – this is a key risk area for all advice businesses. Take time to understand how your risk-mapping tools match the discretionary portfolios under consideration. Any inconsistencies could lead to misunderstandings and possibly poor outcomes for clients.

2. Back-office systems – irrespective of the systems you use, it is important to understand how you will facilitate slick and problem-free data transfer. Mapping all processes at the outset will help to avoid a solution that is too cumbersome to manage.

3. Investment philosophy – do you have a similar investment ethos to your DFM? Share any firmly held beliefs with the DFM; explain how you deliver your service and demonstrate value to clients.

4. Cultural fit – the most common cause for the failure of professional partnership – in 98% of cases – is a lack of cultural fit. Undertake a ‘chemistry test’ to ensure both sides can work together. Check that you share a similar vision and have compatible values.

5. It’s a two-way street – Due diligence must work both ways. Share insight into your business, clients and value proposition. Help the DFM to understand where they ‘fit’ with your service offering and can add the most value.

Why bother?

New research from Rathbones and CoreData shows, in pounds and pence, just how much value the adoption of third-party DFM services can add to an advice business. Advice firms that use DFM are, on average, double the size and look after 20% more clients. They also benefit from higher annual revenues. To me, that’s proof enough that DFM is a viable option to consider for your investment proposition.


About Abbie Knight

Abbie is group head of digital marketing and director at DISCUS.org.uk

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