What should you think about when choosing a model portfolio service provider? We outline six key questions to ask your DFM partner.
Increasingly stringent regulations are prompting many IFAs to partner with discretionary fund managers (DFMs), and utilise platform-based model portfolio services (MPS).
It’s easy to understand why this trend is growing. A 2022 survey by The Lang Cat found that the average adviser firm spends a whopping 71 days per year operating its Centralised Investment Proposition (CIP)[1]. For many advisers, this is time they would rather devote to their existing clients or securing new business.
That said, choosing the right DFM partner can be daunting, not least because of the sheer number of services available.
So how does an adviser go about identifying the best MPS providers for their specific needs?
1. Focus on performance
- Has the DFM delivered strong total returns compared to peers?
- How strong is risk-adjusted performance?
- Has the DFM delivered good risk-adjusted and total returns over longer periods?
It may be tempting to choose a DFM who has achieved short-term outperformance, but performance should be measured with care and over a sensible time period. For example, it is not unusual to find that last year’s worst-performing fund manager achieves top-quartile performance this year – and vice versa.
Periods of three to five years and longer provide a more informed view. It is also important to consider performance over discrete, one-year time periods, in order to ascertain whether five-year performance is the result of outperformance over a very short time period, or achieved gradually over a longer period.
When grading DFMs, total return performance is crucial, but risk-adjusted performance is also important and a key indicator of whether an investment process will provide smooth or stop-start returns.
2. Sensible costs and value for money
- Are the costs competitive?
- Is performance shown net of all fees?
- Can the DFM demonstrate value for money?
Fees have long been a central consideration when evaluating any investment product or service. But it’s not just these costs that an adviser must consider – platform charges, wrapper costs and the adviser’s own fees must also be taken into account. An MPS should therefore be priced at a level that leaves sufficient room for these additional costs.
Under MiFID II legislation, DFMs must provide a breakdown of the total cost of their investment management services, including transaction costs, so advisers can now scrutinise costs with greater clarity and compare DFMs more easily.
Costs should be competitive with the market, but they should also represent fair value. This is a key area of focus under the new Consumer Duty regulations: DFMs will be required to provide value for money analysis of their MPS.
3. Solvency and robustness
- Is the DFM financially sound?
- Do they have an AKG rating?
- Are there any planned changes of ownership that could impact your clients?
Financial strength is important for any company. When evaluating the financial strength of a DFM, an independent measure of an investment manager’s financial strength such as an AKG rating can provide a useful third-party view.
Whilst the assessment behind AKG ratings is complex, the scales used are A (highest), B+, B, B-, C, D (lowest) for the overall financial strength rating.
Recent or planned changes of ownership should also be considered. Whilst not always a negative, a change of ownership might lead to key staff leaving, cost-cutting exercises and changes to the investment process.
4. Attentive service and clear communication
- Are fund updates and portfolio changes provided regularly?
- Are communications suitable for retail clients?
- Will you have a relationship manager and MPS team success?
Good two-way communication is fundamental to forming a close business relationship, developing trust and retaining confidence. DFMs should be in regular communication with their advisers, keeping them abreast of investment views and how portfolios are positioned to respond to the market outlook. They should also inform advisers of upcoming rebalances and say why the changes are being made.
First impressions count. A client’s first encounter with an MPS service proposed by their adviser is often via client-facing literature. Well-presented and clearly-written client literature – perhaps with the option of dual-branding and personalisation – can go a long way to enhancing your client’s experience.
5. Team and culture
- How experienced are the portfolio managers?
- Are they supported by a wider team of investment professionals?
- Do sufficient risk controls and oversight structures exist?
Running a successful MPS over a multi- year period requires an experienced and skilled portfolio management team. However, experience and skill may count for nothing if the portfolio managers aren’t well supported by administrators, fund researchers, economists, strategists and a dedicated risk office.
The team’s oversight structure is particularly important. The investment process should not rely on any one individual and investment decisions should be scrutinised by peers. Risk controls should ensure portfolios are managed in accordance with the agreed mandate and risk parameters.
A ‘good culture’ is difficult to define, but it is often the magic that makes a great team. A key driver of good research and due diligence is a culture that encourages analysts to express their views and debate investment ideas.
6. Enhancing your MPS selection
- Does the DFM have a distinctive and consistent style?
- Do they use a global approach or have a regional bias?
- What market conditions does the DFM perform well in?
Many advisers have a short-list of most- favoured model portfolios and will often split larger client accounts between several DFM partners to achieve additional diversification. Blending DFMs that have different approaches and performance outcomes can help provide a smoother return profile across the economic cycle.
It is therefore important for advisers to understand how DFMs differ in terms of process and philosophy, and how this may affect their performance outcomes. Alongside differences in style factors, advisers should also take note of whether a DFM has a genuinely global approach to investing, or one that is more skewed to specific regions.
[1] Survey conducted by The Lang Cat on behalf Copia Capital Management. Of the 71 days spent operating CIPs, average time spent on reporting consumed 31 days, while monitoring portfolios and maintenance accounted for 15 and 12 days respectively.
