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Divided but conquering? A deep dive into the DFM market

Picture of Russian doll in a cupAs discretionary fund managers continue to grow in assets and importance in the adviser community, Money Marketing research has cast new light on the market’s impact on planning.

More than 400 advisers and paraplanners responded to a Money Marketing survey on the DFM market. Ninety per cent of respondents used at least one DFM and their feedback was overwhelmingly positive: when asked for a rating out of 10, the average adviser rated their DFM 8.7.

The average adviser held 46 per cent of their assets with DFMs and rated performance as the top priority in choosing where to place their client assets. But while all is rosy now, questions have been raised about whether buoyant markets are keeping spirits artificially high, and where responsibility for the end client should lie.

Top of the tree

Brewin Dolphin and Quilter Cheviot came out on top as the most preferred DFMs by advisers. But the big-name brands, with centuries’ worth of heritage between them, engage with advisers in different ways.

Thirty-three per cent of advisers listed Brewin as their primary DFM. Gareth Johnson, Brewin’s head of digital channels and investment services, says that pursuing adviser business has been a strategy for the company over the past five or so years. Advisers represent around a third of Brewin’s assets.

Johnson says: “It wasn’t a particularly large source of flows in 2012. Now the flows are making up a significant part of our business. It was the direction of travel, and understanding advisers’ issues.”

The survey results show that since RDR, 24 per cent of advisers have increased the number of DFMs they use, but 68 per cent say that number has stayed the same.
Quilter Cheviot was the next most popular firm after Brewin, with 10 per cent of respondents describing it as their primary provider. The firm has £23bn in assets under management, with around two-thirds of inflows coming from advisers.

The gap between the two industry powerhouses and the rest of the pack was stark: Brooks MacDonald, LGT Vestra and Parmenion were the next most popular, but all were listed as a preferred DFM by less than 5 per cent of respondents. An in-house DFM was used by 4.7 per cent of advisers.

The average adviser uses 2.7 DFMs, according to the survey results. A fifth each of respondents use one, two or three, with 13.9 per cent using five or more. Discus director Abbie Knight is surprised at the number of respondents who use just one. She says: “Very few advisory firms have a homogenous client bank, with homogenous needs.”

Platforum’s head of intermediary Miranda Seath says it often receives feedback from advisers that firms like Brewin have big central teams, and their regional presence is also very strong.

Several survey respondents revealed that their relationship with their DFMs spanned 20 years.

Who controls the client?

Brewin and Quilter Cheviot employ different strategies when it comes to their relationship with the underlying client, something that Money Marketing understands the FCA could soon be sharpening its focus on.

According to the regulator’s rules, the ‘agent-as-client’ operating framework means that DFMs treat the adviser as a ‘per se’ professional client. According to the Personal Finance Society, the framework was reviewed and maintained over a decade ago, when client categorisation rules were implemented under Mifid.

However, Money Marketing understands the regulator has been in conversation with several DFMs about the model since late last year. The FCA says it is “not able to comment on our conversations with industry which is part of our general supervision work”.

“We took a real stand on the agent-as-client model. I think that really went down well with our advisers,” says Johnson about Brewin’s strategy. In contrast, Quilter Cheviot employs the tripartite model, whereby the underlying investor is treated as the client.

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

Quilter Cheviot’s tripartite agreement means they take on board the suitability requirement for the client, explains head of business development Scott Stevens.

He believes the industry is fairly split in terms of which model is employed. “The benefits to the adviser are that there is a double layer of control and it de-risks their business,” Stevens says of Quilter Cheviot’s model. “The other side of that coin is: ‘isn’t Quilter Cheviot going to run off with my clients because they’ve got a direct relationship?’. The proof of the pudding is in the eating, because we’ve never done that. We understand we’re powered by advisers.”

Portrait of Petronella WestAdviser view

Petronella West
Private client director Investment Quorum

You need to work with a DFM that can work with your client. I have female clients who aren’t going to work with the grey-haired slightly patronising individuals. Then you’ve got more senior clients, who would be more suited to a more senior investment manager.

If you understand your client, you should be confident, going into a meeting with another investment professional there, that you will be able to have good dialogue between all three of you. Your investment manager would need to know the client’s ongoing income requirements, their ongoing capital requirements and any changes to your attitude to risk, and I think having a cohesive, joined-up relationship is in the best interests of the client.

Brewin Dolphin says it has no reason to think the agent-as-client model is under threat. Johnson says: “Our literature and our process makes it very clear for advisers, and I think that is key. We are explicit about roles and responsibilities.”

Knight says the regulator’s interest could be less about the agent-as-client model and rather about how DFMs and advisers understand how the model is going to work. She adds that mapping how the relationship will operate at the outset, including where responsibilities will fall on each side, avoids confusion about how the outsourced relationship will work.

Winning adviser hearts

Just as the DFM market is split on which model it uses, advisers, too, have different views on the relationship between DFMs and the underlying client.

One survey respondent said the DFM must accept that the relationship is between the adviser and their client. Another adviser felt left out of the loop when their DFM emailed the client without copying them into the communications. Several concerns were raised about DFMs swiping clients.

One respondent said they specifically choose their DFM due to the agent-as-client relationship, but another said that framework needed to be scrapped. “Do not expect the adviser to bear all the regulatory responsibility if something goes wrong,” that respondent said.

Several advisers had taken on clients who already had existing relationships with DFMs.

Verve Investment Planning principal Steve Buttercase says the regulator has a responsibility to make sure DFM and adviser relationships offer clear lines of accountability. He says: “When things go wrong they need to be able to see where it went wrong and why it went wrong. What they don’t want is a situation where advisers refer to DFMs and the DFM says: ‘Well, the adviser knew what they were doing’. All the regulator wants is that the client is protected.”

The Cambridgeshire adviser says he’s had mixed experiences with DFMs, but he prefers not to delegate responsibilities. “I don’t like losing the control, because you are 100 per cent accountable to your client. You are the face of the process to your client. You’re always the person giving the good news and the bad news. DFMs have no accountability to the client. They have only accountability to their own businesses.”

Sipp advice gone wrong tells a cautionary tale about the agent-as-client model, says Buttercase. “You see the adviser look at, in good faith, forestry or data centres or whatever it is they were selling at the time. A good pitch by the fund manager, lots of information, lots of confirmation it’s a secure investment and then they go bust.”

The adviser then has to front up to their client, Buttercase says. “While it’s unlikely to happen with DFMs, a similar scenario is always a possibility. You’re effectively delegating some of your control, and you have to accept when you do that you’re not abdicating some of your responsibility.”

Performance pressures

While the structure of the adviser-DFM relationship came through in many of the comments from advisers, performance was still ranked as the most important factor when choosing where to invest a client’s money.

However, some raised questions about how advisers can benchmark that performance, and also about the other objectives investment managers can be tasked with.

While Quilter Cheviot’s Stevens says performance is the raison d’être of investment management, he says the advantage of DFMs over the mutual fund industry is less pressure for “shoot-the-lights-out” performance.

“When you’re in the mutual fund space it’s easy to see what my performance has been and a lot of that performance is built on people having to take larger and larger bets in order to become a top quartile or top decile performer.”

But Stevens argues that’s not necessarily what end investors want. “They want positive returns and they want that to beat inflation. They don’t want you to be taking massive risks with their money; money that they’ve spent ages and ages and blood, sweat and tears earning.”

He says comparing DFM performance to the double-digit returns seen over the past year in global equities markets is comparing “apples and pears”.

Platforum’s Seath says the advisers she speaks to tend to talk about finding DFMs that can meet the objectives of their clients. She says: “Performance is an element of that, but it’s also about how much risk that client is prepared to take on: is that client in accumulation or decumulation?”

Last March, Copia became DFM launched decumulation portfolios, while Parmenion launched its Guardian drawdown portfolios in May the previous year. Seath says this speaks to the fact that DFMs are not just there to deliver stellar performance at any cost.

Concerns over how to benchmark DFMs against each other were raised in the survey responses. “Make whole-of-market performance benchmarking easier and not the DFM’s ‘preferred’ benchmark over their ‘preferred’ time frame,” one respondent said.

Seath says: “It’s hard to measure how the different DFM solutions perform against each other. If they’re saying that’s the biggest factor they’re selecting DFMs on, I’d be interested to know how they’re measuring it.”

Expert view

Matching the DFM to the client is key

With the trend towards outsourced passive services such as Vanguard and Dimensional, and those who run in-house models (advisory or discretionary) we have the market for third party discretionary services pegged at around 60 per cent.

The advisers we work with tend to utilise the services of at least three DFMs. When appointing a DFM it’s important for the adviser to start with their clients in mind. Begin by segmenting the client bank before deciding on the services most appropriate for each segment. Next, define the criteria that are most important to the adviser business and client, then appoint the DFM(s) with the best fit.

We find that those advisers who have undertaken detailed due diligence and matched DFM services to specific client segments tend to benefit from more engaged relationships. Mapping how the relationship will operate at the outset, delving into the detail, including where responsibilities will fall on each side, ensures expectations are met and creates a strong foundation for the relationship.

Our research indicates advisers are less concerned about having their clients ‘stolen’ than in past years, particularly given many use platforms to access DFM services. This model allows the client to tap into the benefits of the DFM, while the adviser retains control of the relationship without direct communication from the DFM.

Abbie Knight is director at Discus

Asset Risk Consulting provides analysis of investment portfolios and compares them to peers and benchmarks. Johnson says they do a great deal with the research company to ensure that advisers have the tools to measure performance.
He adds that awards can be good validation and at least one survey respondent said wealth manager awards had contributed to the rationale for choosing their DFM.

Research house Fundscape is looking to extend its coverage of DFMs from a handful to the entire industry in its annual Gatekeepers research, which analyses fund selectors from direct-to-consumer buy-lists, adviser buy-lists and ratings agencies, as well as DFMs.

Without performance information, Fundscape chief executive Bella Caridade-Ferreira believes that many advisers are relying on longstanding relationships and convincing sales pitches from DFMs.

She says: “If an adviser has a good working relationship, the DFM knows how they work and they’re both singing off the same page, it makes the job much easier. Performance might be a secondary consideration in that situation, especially if you can’t compare.”

Indeed, service levels and ease of relationship ranked almost as highly as performance in the top factors advisers are looking for.

While a long-standing relationship could be interpreted as a sign of inertia, one survey respondent remarked their long-standing relationship with their DFM meant they trusted their “very good experience of outcomes in all market circumstances”.

Accommodative monetary policy and synchronised global growth were supportive of global markets in 2017, but the US Federal Reserve is in the process of withdrawing that support with the European Central Bank set to follow suit.

“What happens in the markets affects how positive in general people feel about these things. I don’t think advisers are immune to that,” says Platforum’s Seath, who says it would be interesting to run the survey again once markets inevitably turn.

Cost conundrums

Adviser sentiment towards DFMs may well change if markets deliver flat or negative performance in the face of a bear market or increased volatility, says Buttercase.  “When performance dips, charges become much, much more important and layers of charges become much more relevant.

“That’s when not just DFMs, but platform charges will come under much closer scrutiny. If you don’t get the returns that can justify the level of charges then you have to be able to explain that.”

The approximate average charge to access DFMs was 0.66 per cent, with the largest proportion of respondents (44.4 per cent) paying between 0.7 and 0.8 per cent, according to the Money Marketing survey results.

Passives and employing buying power to negotiate lower active fund charges were areas suggested by survey respondents for DFMs to improve underlying fund costs. Seven Investment Management was specifically named by respondents as a DFM that is providing such passive solutions.

“More passive players are entering the market and if the industry does not look at the way we charge for the services we provide, more business could be lost to the passive players,” one respondent said.

Advisers are happy with DFMs at the moment, but continued interest in reducing costs through passives could change that, argues Caridade-Ferreira. She says: “Asset allocation can be done much more cheaply than through a DFM. Someone could do your asset allocation for you and you could just stuff it with passives.”

Money Marketing will be hosting a session on the future of investment planning and the role of discretionary managers at the Money Marketing Interactive conference on 3 May. To register now, click here.



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There are 2 comments at the moment, we would love to hear your opinion too.

  1. We have just completed the six-monthly review of the core portfolios and satellite funds that we use for our clients. It’s a mixture of active (mostly) and passive funds. Our selection process is a closely guarded secret but is really quite simple and over the past four years the performance on a like for like basis has knocked any DFM I’ve come across into the proverbial cocked hat.

    I can’t imagine ever using a DFM (unless perhaps for private equity) but that’s because we enjoy the research, seem to be good at it, at least so far, and I’d rather the clients pay us than a DFM!

  2. (Disclosure: I work for MSCI). To those in need of an independent performance benchmark for multi-asset class portfolios, the MSCI WMA Private Investor Indices were designed for just that purpose. One of the significnat differentiators vs. peer-group benchmarks is that each MSCI WMA index represents an investible option (i.e. one could very closely replicate the index performance by investing in the underlying constituents of the index). Plus, index returns are calculated daily using a highly-transparent methodology so that there is full clarity about how returns are derived.

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