In focus - Markets

Six practical steps to selecting discretionary fund managers

Gillian Hepburn, Intermediary Solutions Director at Schroders, outlines six practical steps to help advisers select the most appropriate panel of discretionary fund managers to partner their business.

14 May 2019

Gillian Hepburn

Gillian Hepburn

Intermediary Solutions Director at Schroders

Contributes to
Unstructured Learning Time

CPD Accredited

Sometimes in life we overcomplicate things - and, when this happens, it can often be as a result of the myriad of options and choices available. At a recent visit to a car showroom, for example, I was treated to a lengthy explanation of the various ranges, models and features, including wheel trims, steering wheels, headlights - all aligned to a bewildering array of pricing structures.

Once the salesman paused for breath, he finally asked what my requirements were. "Colour, Bluetooth for making phone-calls, budget and, of course, rear-assisted parking - simple enough?"

I’m often asked how best to go about selecting a discretionary fund manager (DFM) and the showroom experience reminded me of how this process can feel at times. With more than 200 to choose from, all offering a range of propositions, is there a process that can help to make sense of this? Based on my experience of working with financial advisers, here are some suggested steps.

  1. Start with your customer requirements

Unlike the car salesman, start with your customer requirements and consider the following:

What are the client segments and which of those require a DFM solution?

Last year, under the Product Intervention and Governance Sourcebook (PROD), it became a regulatory requirement for all firms - not just product providers - to align products and services to their client segments.

It was also worrying last year to read in a survey, conducted by the Lang cat on behalf of IRESS that 70% of advisers were unsure if they could evidence the suitability of products and services by client segment. Anecdotal evidence suggests this number is reducing but there is still some way to go.

The requirement to comply with PROD is ‘rules-based', not guidance, and good product governance should ensure that products:

  • Meet the needs of one or more identifiable target markets;
  • Are sold to clients in the target markets by appropriate distribution channels; and
  • Deliver appropriate client outcomes.

Now, this is not an article on how to segment clients but I do believe the days of segmenting based on asset size alone are over. Increasingly segmentation is based on life stages, occupation, pre or post-retirement and other factors.

Having defined the client segments, what range of investment propositions are required?

These could include active, passive, low-cost, ethical, ESG (environmental, social and governance considerations), growth and income. 

How should these propositions be delivered?

Options available are;

  • Directly from the DFM on a ‘bespoke basis';
  • In model portfolios both ‘on' and ‘off' platforms; and
  • 'Unitised' - for example, in a multi-asset fund.

To help explore the required delivery, some questions for consideration would be:

  • Does the client have complex capital gains tax issues to be managed?
  • Does the client require specific levels of income that need to be taken tax-efficiently?
  • Do they already have assets on a platform where consolidation can improve charges and reporting?
  • Are specific inclusions or exclusions required in the clients' portfolios?

What services do the clients and the business require and how do these vary based on the delivery?

Client reporting, client and adviser meetings and market communication are examples of key services to consider. Communication with the financial adviser is particularly crucial when using model portfolios on platforms. In this arrangement there is no direct relationship between the DFM and the client. 

The adviser is therefore solely responsible for understanding and communicating any changes to the investment portfolio to their client. That being so, it is important that the DFM can support these conversations.   

  1. Produce a ‘long list' of possible partners

There are various sources that can be used for this and, in my view, a ‘long list' should comprise around 20 DFMs. Some points to consider are:

* Try to produce a varied list

If you require a range of solutions for clients, then you are likely to need a range of potential providers as some DFMs only offer bespoke portfolios, others offer only models on platforms and a number will offer the full range.

At this stage, if using model portfolios on a platform, then you also need to consider availability of those.

* Take a high level look at the business

Last year there were a couple of high profile collapses of DFM business and advisers could review:

  • Financial stability – does the DFM have a financial strength rating?
  • Do the report and accounts demonstrate profitability?
  • Are any FCA investigations pending?
  • What is the complaints history?

* A DFM service is not a retail investment product

In order to remain independent, an adviser does not need to review the whole of the market but the long list does need to contain a good range of providers and propositions - though in line with the customer requirements.

  1. Establish your shortlist

In order to undertake detailed research, the long list should be reduced by around half. Suggested steps to help with this reduction are:

  • Review the customer requirements and sort them into ‘must have' and ‘nice to have';
  • Focus on key requirements on the list, which may be fees and charges (including the treatment of VAT), range of propositions offered, locations, investment process and philosophy, investment instruments used and responsibility for suitability;
  • Use a range of sources for data collection. In its thematic review TR16/1, Assessing suitability: Research and due diligence of products and services, published back in February 2016, the FCA specifically stated: "Firms should consider whether they can rely on the information supplied by the provider." The research must be robust, impartial, objective and based on fact.
  • Map the data against the long list. Identify and exclude those failing the criteria. The regulator also commented in TR16/1 that financial advisers should not ‘retrofit' - in other words, don’t make the due diligence fit the current solution. Be warned - the FCA can spot this! 
  1. Do the detail

This is the ‘deep-dive stuff', which should include meeting the shortlisted DFMs. Research should be both qualitative and quantitative. Quantitative measures could be costs, performance, reporting (do not forget to ask about the MiFID II reporting requirements), investment process and people. How many are there and how many researchers? How well qualified are they? Where are they located and therefore how accessible?

Ultimately, qualitative measures are about culture. These are difficult to measure but can be assessed by meeting the DFM business - not only the people who are managing the money but those who might meet with clients.  Remember - this not a provider-supplier relationship but a partnership. 

Some questions to consider when assessing culture are:

  • What is the ownership and structure of the business? Is it limited, publicly traded, privately owned or is a private equity firm involved?
  • What does the management team look like and is there an alignment of interests across both organisations?
  • Are they an acquisition target? Where might the business be in five or ten years' time? Would a potential takeover significantly impact the way the business is run?   
  • What is the level of turnover? Are clients likely to meet the same investment manager for the next few years - and potentially manage intergenerational transfer of wealth?

Working through the detail and assessing this against the requirements should lead to the production of the final panel, which should still contain a range of options.

  1. Document and share

The golden rule is always ‘If it's not written down, then it did not happen' and, while documentation of the due diligence process and outcomes does not need to rival War and Peace, it should evidence a logical, thought-through process that demonstrates how the conclusion was reached. Many firms also use some of this documentation to help populate their suitability letters

Equally important is the sharing of this process within the adviser business. Ensure that the documentation does not just get put in the - online - filing cabinet and dusted down occasionally. Everyone should understand how the DFM panel was selected and the circumstances in which each DFM might be considered. Consistency of information and advice across the business is vital. 

  1. Individual suitability prevails

Last but not least is that individual client suitability prevails. The regulator was very clear in TR16/1 that clients should not be "shoehorned" into a centralised investment proposition. If the business operates a panel, then clients should be able to meet with prospective DFMs. 

Individual suitability leads me nicely back to the car showroom - for those interested, I am still deciding but I quite like grey.

  • In this infographic, developed with Citywire, we look at how advisers can select the right outsourcing partner.