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What does Mifid II mean for adviser outsourcing?

What does Mifid II mean for adviser outsourcing?

The adviser outsourcing market has grown exponentially over the past 10 years.

The retail distribution review (RDR), which came into force close to four years ago, caused the trend of advisers outsourcing investment management to speed up. This significant piece of financial legislation included the banning of trail commission, a new definition of ‘independent advice’, and the raising of professional standards.

As a result, many advisers reassessed their business models and examined whether it was still viable to provide investment advice in-house.

The introduction of the RDR helps to explain why the proportion of advisers’ client assets managed by discretionary fund managers (DFMs) is estimated to have grown by a third between 2013 and 2015, according to Platforum.

In July 2015, the company suggested that 24% of adviser assets were managed by an external party. Roll forward to April 2017, and Platforum estimates that this figure has grown to 27%, with 19% in third-party model portfolios and the remainder in bespoke mandates.

Looking ahead, can discretionary investment managers continue to attract assets?

Running out of steam?

Figures from Nucleus’s annual census provide a mixed picture. The company found that 44% of a 200-strong sample of advisers planned to either start using a DFM or to allocate more assets to them. Meanwhile, 19% said the amount of assets they allocate to DFMs will either decrease or they will stop using them altogether. The remaining 37% said they do not use a third-party discretionary solution.





David Gurr, managing director of consultancy Diminimis, believes that DFMs can continue to grow their market share. However, much will depend on how they adapt to the MiFID II directive, which comes into force in January 2018.

These European rules are likely to have far-reaching consequences, and have once again caused the question of where responsibility for suitability lies between advisers and investment managers to come to the fore.

This is because MiFID II focuses on a different model of engagement between advisers and discretionary managers, known as ‘reliance on others’. This means that a discretionary manager can rely on a client assessment from an adviser.

‘In practice, it means the adviser can do all of the client-facing work – the fact-find, attitude to risk and capacity for loss – and then that information can be passed to the DFM to construct a portfolio for the client,’ explained Gurr.

According to this framework, the client has an agreement with both the adviser and the DFM via a tripartite agreement.

‘It is absolutely clear who is responsible for what in the process – and both parties have a mutual responsibility for ensuring that interface is working as well as it possibly can,’ said Gurr.

Understanding where responsibility lies within the process is particularly important because MiFID II introduces a requirement that clients must be notified within 24 hours if a portfolio falls by 10% or more. So far, this has created confusion among advisers, discretionary managers and platforms regarding who is responsible for sending out that communication.

Shift away from ‘agent as client’

Gurr believes advisers will move away from the popular ‘agent as client’ operating framework, in favour of the ‘reliance on others’ model post MiFID II. This is because it makes the relationship clearer for the client, regulator and professional indemnity insurer. Agent as client means that the adviser has authority from the client to act as their agent – but Gurr questions whether clients have granted this in reality.

‘Most advisers do not have that level of authority from a client, so fundamentally that is flawed. And if the adviser does have that level of authority from the client, the responsibility as agent puts them at tremendous risk,’ Gurr explained.

Under the agent as client model, the adviser normally selects a pre-existing model portfolio from a range, which they feel is most appropriate for the underlying client. This means they take on responsibility for suitability.

Meanwhile, the discretionary manager is accountable for suitability under the reliance on others rule. Gurr suspects discretionary investment firms which are open to facilitating this framework will be best placed for growth in the future.

While some robo-advice businesses have been set up with this framework in mind, he suspects that discretionary managers will also look to move towards this model.

‘The ideal structure is that the adviser is responsible for all aspects of client information in order to create an investment mandate that clearly describes what the client wants to do with their investments,’ he said.

The method behind converting the mandate into a portfolio by the DFM is crucial, according to Gurr.

‘The really clever way to do this is for the portfolio to be built specifically for the client, so there is no issue of “shoehorning” and everything is specific to the client,’ he noted.

Realistically, a group of clients could have similar portfolios if they have the same objectives, capacity for loss and attitude to risk. However, the process must be client-focused, he added.

MiFID II will also require ‘legal certainty’ within the client agreement in relation to the services that are being provided, Gurr noted. This means advisers will have to review the agreements that are in place with both the DFM and client, and clearly articulate their own role in the process.

Downward fee pressure

The new European regulations also aim to improve transparency – a move that many expect will cause charges to come under pressure.

‘At the moment there’s lots going on in the way of negotiated fees across the board. If an adviser has got a significant amount of assets under their care, they are going to be discussing that with a panel of discretionary investment managers,’ said Gurr.

‘What we have found when we do due diligence is a number of high-quality firms are reluctant to give a standard fee chart because they are prepared to negotiate fees, dependent on the assets coming their way,’ he added.



Jillian Thomas, managing director of Future Wealth Management, agrees. ‘Post 3 January when MiFID II comes in, there is going to be an open, clear discussion about cost,’ she said.

Like Gurr, she is also seeing charges come down. However, she acknowledges that this could be down to a range of factors alongside MiFID II.

‘We are now in a situation where we are being offered the best terms and I have also got the ability to ask for better terms. I have found the providers are happy to open that discussion at the moment,’ she said.

Future Wealth Management currently works with discretionary investment firms in different ways across its client base – and Thomas expects these relationships will continue. For example, Future uses Seven Investment Management and Parmenion for clients with smaller portfolios. Meanwhile, Brewin Dolphin manages money on a bespoke basis for clients with larger portfolios.

‘We want good charges, good communications with clients – and I want clients to be able to see a company that is working in their best interests,’ she added.

While some advisers prefer for there to be no interaction between the discretionary manager and client, Thomas is happy for the investment manager to attend client meetings.

‘I want the DFM to be a part of the team because I want the client to be engaged, but I also want that DFM to see who they are making decisions for,’ she said.

Demonstrating value

Nick McBreen of Worldwide Financial Planning questions whether the trend towards outsourcing investment will continue unabated.

‘I believe a lot of advisers have introduced discretionaries into their business model because they don’t want to do the investment, risk planning, the attitude to risk planning, fund selection and asset allocation. They want to just push that away to a Quilter or Brewin Dolphin and leave them to do the heavy lifting.

‘I don’t understand how you add value to the client and still charge your fees to do that. I think that is going unravel,’ McBreen said.

He added that appointing a DFM can be appropriate if the client has a specific need that the adviser is unable to fulfil in-house. For example, AIM inheritance tax portfolios.

However, advisers who have assumed that appointing an investment manager absolves them of responsibility for suitability are likely to get a surprise. He says this is because they must not lose sight of their responsibility to make sure that the discretionary solution is appropriate.

Risk-profiling warning

McBreen also warns that advisers need to be careful not to rely too heavily on external risk-profiling tools. He suggests that there has been a drive to ‘commoditise’ and shoehorn clients into model portfolio solutions using external risk profiling tools. At the end of the day, advisers must ask themselves whether the solution is truly reflective of the individual clients’ circumstances.

‘People are still individuals. No-one is the same and it is very easy to walk past that. You need to slow down and get those key questions absolutely right,’ he added.

Gurr echoes these sentiments. ‘It is the adviser’s responsibility when they use these external tools to understand what they are using and if they are 100% accurate for what they are trying to achieve,’ he said.

So what is likely to lie ahead for the outsourcing model in the post-Mifid II world? Discretionary managers have the potential to attract more assets from advisers. However, both advisers and discretionary firms must work hard to ensure that the client stands at the centre of the process.

Source (all charts/data): Nucleus 2017 Census


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