Why I’m not surprised DFM is becoming more popular

Earlier this year, Andrew Bennett, our Chief Executive Officer, took part in an excellent New Model Adviser roundtable event looking at how advisers and planners can identify the right DFM solution.

I recently reread the coverage of the debate, which you can find by clicking here, as well as fascinating research from Nucleus on the same subject. Both got me thinking about the role DFMs currently play in the advice and planning process.

The case for specialists

As anyone who reads my monthly musings will know, I’m a firm believer in the benefits of employing specialist expertise. If I’ve got a painful back, I’ll visit my GP, but only to access specialist chiropractic support. That in no way denigrates my GP’s knowledge or experience; but the complexities of the spine mean I want specialist care.

The same is true when it comes to managing money. I’ve always believed financial planning and investment management are two different things. Consequently, I believe advisers and planners should spend their time focusing on where they can add the most value, leaving investment management to those for whom it’s their sole focus.

Again, I’m not denigrating the work of advisers or planners. Quite the contrary; I believe so strongly in the value of financial advice and planning that it shouldn’t be watered down by adding the complexities of investment management.

Those who disagree will probably do so because they believe clients value their investment management skills. In my experience, this couldn’t be further from the truth. Sure, clients need their capital invested prudently, with returns in line with their expectations and requirements, but do they care who, or (within reason) how, that is delivered? Probably not. The value to the client is the trust he or she has in the adviser and their recommendations.

So, if outsourcing investment management is the answer, what can we learn from the New Model Adviser round-table and Nucleus’s recent research about the role of DFM?

The use of in-house model portfolios is increasing

To be truthful I’m surprised at this.

I’ve always believed that in-house model portfolios, run on an advisory basis, have significant drawbacks compared to a carefully chosen DFM solution.

Firstly, the model portfolios need to be built, a task which requires specialist expertise and brings us back to the in-house / outsource debate. Secondly, the requirement to obtain client consent for each change creates a significant administrative burden and introduces an additional element of risk. Given that burden when changes need to be made, and the associated cost to the adviser firm, there can be a tendency to leave things as they are. That isn’t a good outcome.

Finally, outside of a tax-wrapper the disposal of individual funds creates tax complications.

Obtaining discretionary permissions

The changes introduced following MiFID II, coupled with the administrative burden of running model portfolios on an advisory basis, has previously led to some firms to consider applying for their own discretionary permissions.

However, as the greater regulatory and capital adequacy burden becomes clear, the pace of applications has slowed. Indeed, the Nucleus research shows that the number of firms considering this option has dropped by half over the past two years.

Don’t be distracted away from total cost

Periodically pressure is applied to the cost of each element in the value chain (advice, platform and investment). Some believe the cost of investing is too high, others feel that the advice fees should fall. At the same time, the cost of platforms and who should pay for them (the adviser or the client), is hotly debated.

Despite an expectation that greater transparency resulting from MiFID II will force some of the more expensive DFMs to cut charges, the presumption of many advisers and planners is that they are too costly. It’s a view I have some sympathy with.

In many respects though it’s a red herring. Each element of the value chain needs to be competitive, but it’s the total cost which is most important. The danger is that we focus on one element, forgetting to look at the whole picture. Or worse, dismiss DFM as a potential solution based on an outdated misconception that it’s always too expensive.

So, is the answer DFM?

From fixed fees to non-contingent charging, active to passive, our profession is plagued by people telling anyone who will listen there’s only one answer, theirs.

While I’m happy (from time to time) to climb on my soapbox, I’m less comfortable in a pulpit, so I’ll spare you the sermon. However, I firmly believe in two things:

  • Outsourcing investment management reduces risk, creates more scalable businesses and produces better client outcomes
  • Using a panel of DFMs, following a wider process of due diligence, should form part of that solution

Only you will know what’s right for each segment of your client base. However, I can certainly see why DFM is becoming a more popular option for those advisers and planners who want to let go and take control.