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Blog: Advisers should be wary about using DFMs

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Blog: Advisers should be wary about using DFMs

Perhaps naively, I believe the IFA service we offer to our clients is based on the three guiding tenets of trust, clarity and simplicity. I have not heard an argument in favour of discretionary fund management that enhances these principles.

Looking at discretionary fund manager (DFM) marketing literature, I am struck by how little their service appears to be designed for the benefit of the investor, instead concentrating on the apparent benefits to the IFA.

They offer incentives for advisers: have more hours in the day, transfer the client risk to us, and free yourself from the day-to-day involvement in client’s investments.

These assertions may have some foundation, but with most DFMs applying ongoing charges between 0.5% and 1.5% per annum, this cost is inevitably being passed on to the client and presumably reducing the adviser’s margin.

Rising costs

The only certainty of adding a DFM to the client relationship is the overall cost of advice for the consumer will increase. Any compensation in terms of added value is harder to measure and unlikely to warrant the cost.

By its discretionary nature, it is impossible to draw comparable data on fees and charges, and the lack of transparency does not end there. It is difficult to find DFM performance figures in the public domain and even harder to make direct comparisons between different providers.

New websites are emerging that compare service levels, but comparison of cost and risk-adjusted returns do not exist.

Their marketing literature tells me my role as the IFA is to provide the client with financial planning, whereas all investment management should be subcontracted to what Emma Wall, senior editor at Morningstar, calls ‘highly qualified investment professionals’.

If this is the case, surely these companies should be measured on their ability to deliver risk and cost-adjusted returns? Almost all other measures of value remain in the domain of the adviser.

Performance comparison

Technology now makes comparing the performance of individual fund managers against their peers as simple as subscribing to the appropriate analytical comparison site, applying the necessary clicks, and producing an accurate and client-friendly document.

The transparency of clean share classes created by the retail distribution review and comparative software frees us from day-to day involvement in clients’ investments. The use of opaque and unaccountable DFMs must be a retrograde step requiring far more due diligence than stochastically asset allocated, risk-controlled model portfolios.

We are all striving to improve our businesses, increase our profitability and improve the client experience, but I would caution anyone enlisting the services of a DFM, and question whether this approach brings efficiency and reduces risk.

Blame game

As the professional client of a DFM, all investment suitability responsibilities rest with the adviser, despite having no control over what the DFM does in terms of asset selection or asset due diligence.

If your DFM fails to deliver the returns you were expecting, who do you think your client will blame, and how do you justify any change to another equally unaccountable DFM?

As regulation and costs increase, there is a temptation for smaller advice firms to look to reduce risk and outsource. They become easy prey for national consolidators looking to increase margins and industrialise the provision of advice, reducing client contact and centralising investment strategies.

Migration towards discretionary fund management feels inevitable, but trust, clarity and simplicity are the keys to strong client relationships. It has never been easier to be an investment professional as well as a financial planner, so let us not sell ourselves or our clients short.

Matthew Pescott Frost is director of Matthew Douglas.

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