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DFM portfolios branded ‘closet trackers’ as adviser research slams behaviour

Portfolios run by discretionary fund managers such as Quilter Cheviot and HSBC appear “closet trackers” as pressure increases on the industry to justify its fees.

Advisers have reported changing their clients’ portfolios after finding that many DFMs they were outsourcing investments to were not making active calls in some of their funds.

The comments come as the inv­estment industry comes under inc­reasing scrutiny from regulators regarding its value for money. Many fund groups have been urged to justify higher charges under new disclosure rules.

Blue Wealth Capital independent financial planner Raj Shah tells Money Marketing that his research shows some DFM groups keep clients in portfolios that charge like active funds but on many occasions mimic an index.

He says: “What we found historically is that a lot of the DFMs out there that we’ve used are as close as 99.95 per cent to a tracker. We looked at some well-known DFMs that have charged clients 2.5 per cent a year for being a tracker.”

Shah used the R-squared metric on Financial Express to calculate to what extent a fund’s constituents differed from those in its benchmark.

Tracking error and active share are also ways to conduct similar analyses.

As a result, the adviser has moved clients directly into other funds, such as those at BlackRock and Vanguard which are included into EBI portfolios.

According to Morningstar, a mutual fund with an R-squared value between 85 and 100 has a performance record that is closely correlated to the index.

Money Marketing has seen research showing that among the wealth managers that tend to follow indexes closely according to the metrics are HSBC Global Asset Management and Quilter Cheviot. Using the R-squared metric, an 80 per cent equities portfolios by Quilter and HSBC had a R-squared value of 91 and 94 respectively.

In comparison, the same portfolios with EBI Portfolios had an R-squared of 74 and 83.

Shah says: “When moving one client from one place to another, you see the funds and what’s underneath. You can say: ‘The discretionary fund managers looking after the fund after we have analysed it, they have tried to replicate the index. Why are you paying 300bps for someone to match the index?’”

A recent poll by Money Marketing shows that advisers are split over whether DFM fees represent good value for money, with 42 per cent arguing they do not, 38 per cent believing they do, and a fifth of respondents remaining unsure.

The FCA is currently looking at DFMs’ role in the value chain as part of its platform market study to see whether the extra costs to investors are justified. Issues around wealth managers’ value for money were also previously flagged in its final asset management market study, which was published in June.

Thameside Financial Planning director Tom Kean thinks that, if there are DFMs out there that are closet trackers, they are “fools”.

He says: “Some [DFMs] don’t seem to add much value. I am sure the good ones do. But they shouldn’t be just tracking an index, otherwise you will stick to a tracker.
“If DFMs and other fund managers are closet trackers, they are shooting themselves in the foot and giving fund managers a bad name.”

Kean adds: “The new cost disclosure requirements are good for advisers and consumers but probably not very good for DFMs because they are going to have to focus more sharply on what they are charging and what value they bring.”

A Quilter Cheviot spokeswoman says: “At Quilter Cheviot we provide a clear and transparent charging structure for our discretionary portfolio service proposition. We believe our active approach to research adds significant value to the service we offer our clients; our 22-strong in-house research team make recommendations and specialise in researching direct equities and fixed interest, as well as providing fund research and analysis of all third-party manager investments to create bespoke portfolios for our clients.

“Our technical expertise enables to us implement our investment ideas efficiently and cost-effectively. We remain top quartile for returns in our Balanced, Steady Growth and Equity Risk PCIs over 5 years.”

‘Partially active’

Money Marketing reported last September that more advisers were looking to bring investments in-house as 11 per cent of IFAs planned to get discretionary permissions in the next five years, according to Platforum data.

Tatton Investment Management chief executive Lothar Mentel says that returns are only part of the picture when using a DFM. He believes that the FCA’s asset management review will turn up evidence that DFM-constructed portfolios also display less volatility than model portfolios constructed in-house by advisers, and provide a better match to risk ratings.

Mentel says: “We are not promising to shoot the lights out. We will get the return appropriate for the investment risk you are willing to take.

“The client gets the outcome they asked for rather than the random risk and leaving it up to different portfolios.”

While the FCA has been clear that it does not prefer one type of fund over another, it has criticised some individual funds for being “partially active” with only “modest positions” around their benchmark.

Some managers are introducing steps to reduce their charges when funds underperform, so advisers will pay full-fat fees only when they beat an index.

Fidelity has been the most high-profile example of this, where fees can vary by as much as 0.4 per cent depending on performance.

Commentators have also pointed to additional pressure on DFMs from the rise of self-directed inv­esting. For example, Interactive Investor plans to introduce a DFM service following its acquisition by TD Direct.


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There are 3 comments at the moment, we would love to hear your opinion too.

  1. Why no mention of the other services that DFM’s can provide like maximising the use of CGT exemptions annually and funding ISA’s? It’s not always just about the investment.

  2. If your research is even vaguely right, 20% of responses from advisers that are “unsure” if the DFM that they have selected is good value for money is somewhat alarming…. or was the question posed in such a way, that it was a generic, industry-wide logical response?

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