4 minute read
To DFM or not to DFM, that is the question
IAN JONES CEO, Fundhouse
Over the past five years, there has been unprecedented growth in the popularity and influence of Discretionary Fund Managers (DFMs) in South Africa. At last count, there were more than 40 DFMs up and running. The surge in popularity has been driven by a range of factors, including:
• The release of the first discussion paper on the Retail Distribution Review (RDR), which proposed increased scrutiny on an adviser’s investment process and the associated compliance requirements
• The professionalisation of the advice industry in South Africa, with many advisers shifting from operating as a ‘book of clients’ to managing an advice business with the benefits of scale and process that brings
• More platforms (LISPs) developing the capability to administer model portfolios and communicating that to advisers in the market
• Fees dropping for DFM services to levels more palatable for advisers and their clients.
What are the benefits to an adviser of outsourcing their investment process to a DFM?
The key benefit of outsourcing the investment process is to introduce an additional level of investment expertise into an adviser’s process. A DFM would be expected to provide detailed fund manager research to enable appropriate fund selection, portfolio construction skills, the continuous monitoring of portfolios, and rebalancing of portfolios when needed. The aim would be to deliver consistent investment outcomes for clients over time. It is important that over an appropriate timeframe, DFMs are held accountable for the investment performance of the portfolios they manage from a risk and return perspective.
Investing offshore should be a key part of the DFM’s offering, and a DFM should deliver significant value in terms of understanding the global investment universe and the funds that are options for an adviser’s clients. The sheer scale of the offshore investing options should mean that outsourcing to a DFM – with their research team and capacity to cover the options – adds value.
Clearly, there are advisers who have the skills and experience to be able to implement their investment process themselves. However, another benefit of outsourcing this specialist requirement is that it allows the adviser to focus on building their core business, their advice proposition, and to have more time to service their clients and grow their client base.
A third benefit of outsourcing to a DFM is to provide administrative and implementation simplicity across the adviser’s business. The adviser has the ability to consistently and efficiently implement their investment advice across their client base by using a range of portfolios through a Discretionary Category II licence – either that of the DFM, or their own.
A fourth benefit of outsourcing to a DFM is one of governance and compliance. The DFM should be able to ensure that similar clients are treated consistently (and therefore reduce TCF concerns), that the adviser has a documented investment process, and that comprehensive due diligence is provided on the funds used.
The RDR discussion paper led to many claiming that independent financial advisers (IFAs) would struggle to survive and thrive once the RDR is implemented, and that IFAs would need to either sell their business to a corporate or outsource to a DFM. We do not agree with that assertion. We believe that the majority of investment IFAs do not have to make material changes in their business to comply with RDR, and we do not believe that this should be the reason for using a DFM. It is an added benefit but should not be the key driver.
In summary, the services of a quality DFM offers a financial adviser:
• An evidence-based investment philosophy and process that aligns with the business’ advice framework
• A sustainable investment range that is able to cater to different client needs
• Consistently managed portfolio solutions across the client base
• Access to a dedicated team of investment specialists
• Consistent and cost-effective implementation across different investment platforms
• Constant compliance with the various regulatory requirements.
Are All DFMs the same?
Advisers are clearly spoilt for choice given all the DFMs now operating in South Africa. However, because they are still a relatively new concept to many advisers, choosing a DFM can be overwhelming. The right DFM has the potential to be a transformative, long-term business partner to an advice business.
We believe that the two most important factors that advisers need to consider when choosing a DFM are to: 1.Understand the unique value proposition of the DFM, given how different the various DFMs’ offerings are, and how this value proposition complements the advice process 2.Make sure there is a good culture and philosophy fit between the adviser and the DFM.
Meeting these considerations will decrease the probability of ‘buyer’s remorse’ from an adviser who is getting something different from what they expected, and ensures that when differences of opinion emerge, there is common ground and respect between the parties to allow for a compromise that does not disadvantage the client.
Key factors to investigate when carrying out your due diligence on the DFM options include:
1.Is the DFM independent and how important is independence to the adviser?
2.The investment philosophy and performance history of the DFM
3.The depth of the DFM’s global and local research capabilities
4.Global and local portfolio construction capabilities
5.The skill and relevant experience of the core investment team
6.The DFM’s back-office compatibility with the adviser’s current processes
7.The scale of the business
8.The fee structures.
In our opinion, DFMs do have an important role to play in helping advisers to professionalise and grow their businesses; ensure consistent investment outcomes; improve communication to clients; and enable advisers to focus on their core role of giving comprehensive financial advice to clients.
