With the increase in number of Discretionary fund managers and Model Portfolio providers in the market, Advisers face a proliferation of options to consider. When using discretionary models as a part of a Centralised Investment Proposition it is critical to undertake extensive due diligence on the providers as you will be embarking on a close working relationship based on trust to achieve the best outcomes for your clients.
The FCA uses the expression research and due diligence to refer to the process carried out by the firm to assess (a) the nature of the investment (b) its risks and benefits and (c) the provider. The firm needs to understand these factors in order to judge whether the solution is suitable for their particular client base. With this in mind, we look at 7 key areas to consider before partnering with a discretionary service provider.
(a) assess the nature of the investment
1. Investment mandates and methodology: Number one on the agenda is to determine what your investment proposition seeks to achieve and how that is achieved.
A majority of DFM providers offer risk optimised or risk targeted models that aim to offer viable solutions for the majority of investor profiles. Reviewing the methodology used to create the portfolios is key to understanding what sets one provider apart from another. How are the models put together? How many asset classes do the portfolios cover? How many funds? Are they deterministic or stochastic? Are they high conviction or fairly neutral? Are they built using quant and qual selection? Looking for third party validation of portfolio construction/methodology can help you select the best of breed.
Results from a survey of FE adviser clients found that more than half of advisers that use model portfolio service providers (52 per cent) only use a single provider. In this case, it is beneficial to work with a provider that offers a variety in risk grades (income, cautious, balanced, adventurous etc.) to prevent shoehorning clients using the 'one size fits all' approach.
2. Considering term: Despite the regulator's ongoing emphasis on the need for firms to adequately gather customer information and do more to ensure that the composition of the recommended investment portfolios truly reflect the risk appetite, investment term and personal financial goals of their customers - little is done by away of accounting for term/time horizon in many outsourced investment products available to Advisers. Whilst investing in collectives largely means investing for long-term returns, it can often be in conflict with an investor’s current situation (e.g. age) or investment objectives, making it challenging for Advisers to establish and maintain ongoing suitability.
Further, the risks involved investing for the short-term (e,g. market risk) can vary significantly from risks involved in longer term solutions. Selecting a discretionary provider that offers term weighted portfolios at each risk level can help you alleviate these risks and offer clients more tailored investment options although you are using ready-made portfolios.
(b) assess its risks and benefits
3. Comparisons offered: Armchair critics of DFMs and model portfolios have often commented on the lack of transparency within the industry when it comes to portfolio performance comparisons, costs etc.. making it harder for advisers to select the most suitable provider for their needs. When we surveyed our Adviser clients in early 2014, although 70% of respondents were invested in a DFM, 40% found it 'extremely difficult' or 'very difficult' to research options available to them. Since then however many of the UK's leading providers have committed to improving transparency by making their models available on research tools such as FE Transmission.
What this means is that Advisers are able to truly get under the bonnet of the portfolios they are invested in at a holdings level and use comparable data and benchmarks to review risks and benefits associated with individual models. The service also allows for bespoke reporting - helping advisers establish a robust paper trail of the due-diligence conducted.
Click here to find out more about FE Transmission >
4. Ongoing governance: Assessing and managing risk demands a consistent, robust governance process that the DFM provider ought to support Advisers with. This usually takes the form of timely reporting and descriptive content on factors that affect your model/portfolios including macro issues, individual fund updates, market commentary and more. Ensure that the provider is fully transparent whilst making any changes to the portfolios providing you adequate information explaining reasons for fund switches.
5. IT security: The trade press recently reported on a UK DFM who was very unfortunately hit by a cyber attack. It is wise to have a detailed conversation with providers you may want to work with on their cyber security initiatives and data protection policy. Ensure that their internal systems are protected by a comprehensive security framework (preferably ISO accredited) and go through specific scenarios like phishing attacks to understand preventative actions and risk management procedures.
(c) assess the provider
6. Independence: Due diligence on the provider should entail careful understanding of how independent their investment process is. Do they truly review the whole of the market? Do they charge a fee for risk mapping certain funds to any risk profiling tools? An Adviser's independence and integrity is largely linked to the providers they choose.
7. Access to team: When investing your clients' assets in a DFM, you are essentially investing in their specialist knowledge and expertise. Hence is it imperative to gain insight into the team managing the models by reviewing their track record, checking the number of staff assigned to reviewing funds/sectors, their qualifications and experience, internal training and development initiatives and most importantly the level of contact you will have with the managers.
We hope you found the above useful. Are there other areas you look at whilst researching DFMs? We would love to hear from you at enquiries@financialexpress.net