Is your DFM due diligence “soft” enough?

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Discretionary fund manager research and due diligence has been an area of persistent concern for the FCA for some time. Alongside risk profiling and cost, it is one of the key risks the regulator has highlighted which can lead to unsuitable advice and needs attention.

Encouragingly, there have been significant technology developments in this area recently with the emergence of several DFM due diligence tools offering advisers an objective, data-driven view of DFM performance, charges and financial strength. Sophisticated as these tools are, they inevitably focus on quantifiable factors and pay far less attention to the “softer” elements of due diligence. These soft factors are tricky, but not impossible to assess.

The key challenge is to identify a partner who will enrich the service offered to a specific client segment. That service will be a product of the joint efforts of adviser and DFM and relies on effective coordination between the two. For this reason, it is crucial to gain as much insight as possible into how a relationship will be governed before committing to a partnership. Gone are the days when reputation and financial strength alone were enough.  

There are six distinct areas that ought to be considered:

Target clients –The PROD Handbook entitles the regulator to request sight of the method by which an organisation identifies its target clients and the steps which have been taken to ensure that any product or service offered is designed with those clients in mind. This extends to third party relationships such as DFMs, so it is important to ensure there is consistency here. If a firm’s target customer is relatively financially savvy, does the DFM firm being assessed offer the type of reporting a customer would value, and does it fit with the broader service being offered?

Governance – What is the DFMs approach to updating advisers on a change in investment approach? The likelihood is that it will be the adviser articulating this change to clients, and a clear understanding of the rationale for any change is essential to achieve good client outcomes.  

Culture – The FCA’s thematic review TR16/1 highlights a culture of challenge as key to conducting robust due diligence and it is important to test any prospective DFM partner’s processes for reviewing and challenging their own performance. A healthy attitude to reviewing the success of any relationship will ultimately lead to an improved service being offered to mutual clients. 

Complaints history – A complaints history on regulated entities is available via the FCA website and can be remarkably revealing when evaluating a potential DFM partner. Does the data throw up any red flags and are there any noticeable trends?

Operating model – An assessment of the main pillars of an operating model can provide valuable insight into the suitability of any DFM for a customer segment. Even at a high level, an awareness of organisational design, systems architecture, process robustness and team structure will reveal the practical realities of a potential partnership.   

The humans – Despite the hyperbole surrounding new technology, people are the backbone of any business and invariably the determining factor in its success. Research into the background of senior management and the company’s history of promoting from within will provide valuable insight into the calibre of people involved.  

The evolution of due diligence continues at a brisk rate and advisers will undoubtedly benefit from the recent emergence of new systems. However, before we get swept along by the deluge of data, let’s not forget the more subtle winds and currents which also affect our journey – we need to navigate all of them to make sure our clients are not swept out to sea. 

Sam Turner is a consultant at Altus

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