Investment managers are facing a moment of reckoning. The coronavirus pandemic has left markets – and therefore fund houses’ revenue streams – in uncharted territory. This is a huge test for active managers in particular – investors believe they are paying a premium not only to outperform markets on the up, but also to be able to react to such crises to cushion the falls.
Not everyone can beat the market, or even meet client expectations, at a time like this. But for those discretionary fund managers that can really prove their worth in the toughest of moments, the road ahead looks significantly brighter. You could argue that significant outperformance right now is exactly what clients are paying for.
As Money Marketing’s annual DFM Satisfaction Survey shows, while there are certainly headwinds buffeting outsourced investment managers – both Covid-19 and elsewhere – there are plenty of market dynamics that are playing right into their hands.
Wealth of expertise
Although we invited opinions from all advisers and paraplanners, even if they didn’t use outsourced investment management, the sample for our survey may have naturally attracted keen users of DFMs as those most likely to want to be heard.
The starkest illustration of this was that 20 per cent of respondents used five or more DFMs – up from 12 per cent last year. This compared to five per cent that did not use any. Of the respondents, 22 per cent used just one DFM, 25 per cent used two, and 21 per cent used three DFMs.
While the sample may have an element of self-selection, it does also confirm anecdotal evidence that advisers tend to hold on to legacy investment manager relationships when taking on new clients. Across a client bank of 100 clients, for example, this could well be up to at least five DFMs for an adviser.
The wide breadth of panels could also be reflective of the FCA’s product governance requirements, and advisers taking greater care with their approach to segmentation this year. The rules require advisers to make sure the products that are put into particular clients’ hands are appropriate for that type of client. This could naturally fit a due diligence exercise where a different DFM is selected for those that would benefit from passive or ethical investment exposure, for high-net-worth clients versus lower net worth ones, younger clients, older clients, or those in accumulation rather than decumulation.
Crowe UK financial planner Aron Gunningham tells Money Marketing his firm uses six DFMs on its panel, each meeting different risk profiles, investment strategies and adviser preferences. He says some DFMs are better at different risk levels, or at dealing with stocks compared to fund management, for example.
While slightly more respondents added to their panel rather than decreased it – 22 per cent compared to 18 per cent – most still kept the number of DFMs they used consistent from the year before. A total of 60 per cent said the number had remained the same.
Taking on a new team
Those adding to their panel reported a whole host of different reasons for doing so. These ranged from cost differences, onboarding hassles and niche requirements from clients to concerns over the long-term stability of DFM providers.
One adviser wrote that they had made “changes due to reduced long-term performance, takeovers and altered financial security/stability”.
Another said that they had acquired a company with an in-house DFM, so had to change their model, while a similar reason was given by others who had started working with new advisers who already had a favourite DFM.
Some cited simple “diversification” as the reason behind their move to add DFMs to their panel – whether this was in terms of underlying fund/stock selection or diversification by manager was unclear.
When it came to panel reductions, advisers also marshalled a variety of motives for wanting to cut their panel. One said they wanted to concentrate into ethical, social and governance funds. Others said they didn’t want to run the risk of over-trading, wanted to retain greater control of the investment proposition, lower costs or cut the burden of due diligence.
“[We wanted] to make life simpler in a very complex world and to gain a deeper and better relationship with the DFM involved,” one wrote.
While the reason for altering a panel can be based on business needs rather than poor service from a DFM, some advisers cited particularly painful experiences as the reason they ditched a partner.
Multiple feedback forms in Money Marketing’s survey referenced consistent investment underperformance from a manager. “Too many of the current providers are high-cost,” was the verdict of another respondent.
Fears of client poaching reared their head as an explanation by some advisers for DFM scepticism.
One adviser went further, saying they had ditched their investment manager because they “take control and act against client wishes, and shoehorn them into their own requirements rather than those of the clients”. An example of this, they said, was that the DFM had put clients in above-average risk funds during their retirement.
Sunny side up
But despite these detractors, on the whole, advisers appear to be relatively content with what they are getting from outsourced investment managers.
On average, our sample rated their satisfaction with their DFM partners at 7.8 out of 10. A greater proportion – 18 per cent – said this had improved in the last twelve months, compared to those who said it had deteriorated – 13 per cent.
These results could certainly be seen as a positive for a sector that has come under increased scrutiny in recent years. A cost-aware regulatory environment will not play into the hands of those DFMs that cannot illustrate outperformance or other value commensurate to the price paid for their use. New challengers with cut-price entry points are only increasing the spotlight falling on the wider investment management sector.
The proportion of advisers in our sample more satisfied with their DFM than the year before remained stable. However, the proportion of advisers saying their relationship had deteriorated did increase slightly – potentially as competition shone a light on some of the less adviser-friendly offerings in the market.
The stereotype of the teak-walled DFM office undoubtedly persists in some parts of the market, and it’s only understandable that advisers seeing those excesses will have become more disenchanted with them than before.
But even the new brigade has had to stand up to adviser questioning due to the chaos in the wider markets. DFMs have had to ride out challenges of sending 10 per cent market drop notifications under Mifid II rules for the first time, and co-ordinate with platforms that are often still behind the curve when it comes to dealing with complex decumulation portfolios in particular.
Brexit and a change of government were thrown into the mix well before Covid-19, putting constant uncertainty into the minds of investors – even during the record bull market we enjoyed.
Filling the buckets
Nearly 60 per cent of advisers in our survey held at least half of their assets with DFMs, against 16 per cent who said that proportion was less than 10 per cent. Just over a tenth of advisers held between 90 and 100 per cent of their assets with DFMs – indicating that it is still uncommon for advice firms to outsource their investment management lock, stock and barrel to a DFM.
Instead, this adds to other evidence in the market that the numbers of advisers dipping their toe in the DFM market has increased, even if there hasn’t been a significant jump in the proportion of assets the average adviser is using a DFM to manage. The most common choice for advisers in our sample was to hold between 70 and 80 per cent of client assets with DFMs.
Many are putting the slight upward trend in the proportion of adviser’s assets held on DFMs down to a more general movement in the advice profession towards dealing with higher-value clients.
As the cost of providing advice has increased in the aftermath of the RDR many financial planners have opted to move up the chain and focus on wealthier clients to maintain their profit margins. Particular opportunities abound for those moving back towards a private office model as banks have exited the planning market, and intermediaries focus more on how to secure the next generation of family wealth when client and adviser banks are continuing to age.
The clients serviced by these types of firm typically have investment and tax needs that tend to favour bespoke portfolio management and the expertise of a DFM rather than an advisory or model portfolio managed in-house.
This trajectory has been complemented by increased discussion of coaching and life planning in the advice profession, which is only likely to be exacerbated by ongoing market turbulence; more planners want to focus on the job of planning, reassurance and wellbeing of their clients, and leave the investment bit to someone else.
Picking the right poison
No single provider shone above the rest when it came to being the advisers’ primary DFM. Money Marketing presented respondents with a list of the top 20 DFMs, based on research by consultancy Platforum, and asked which was their main partner. A third of respondents said their primary DFM was not on the list. Seven per cent of respondents said they had an in-house DFM.
Among the named providers, Quilter Cheviot, Brewin Dolphin and Brooks Macdonald were the most common selections. For those selecting ‘other’, P1 Investment Management was the most common choice.
When asked why their preferred DFM stood out from the crowd, track record and strength of relationship really shone through in the comments made by our advisers and paraplanners, as well as an ability to understand the process, risk controls and asset allocation that were going on behind the scenes.
“We have used them for over 10 years and trust them,” one adviser said. “Quality service and proven trustworthy managers” another added.
“They are a good local fund manager which is very skilled and consistently outperform the market. They are easy to meet up with face to face to discuss portfolios and present to clients.”
Glowing reviews included: “They are the most professional outfit and have a proven track record with us, with consistent returns and client relationship building.”
While having an ample supply of business development managers around the country is occasionally considered an extravagant cost, or a relic of pre-RDR inducement days, the feedback from our survey suggests that personal contact is still something that is highly prized by IFAs.
Flexibility and technological capabilities were also frequently featured in the respondents’ comments.
“We feel in control and can react to clients very quickly,” said one, while another adviser praised a DFM’s integration with their customer relationship management system.
However, a deep personal relationship can’t always pave over the cracks when they occur. One respondent wrote: “They are not my choice personally, [but] the adviser likes the manager. It annoys me that the choice is not researched, but based purely on personal preference.”
Cost crunch time?
When it came to charges, a fifth of advisers claimed they paid less than 0.2 per cent for their DFM. This was around the same proportion of the sample that said they paid between 0.3 and 0.4 per cent and 0.5 and 0.6, respectively.
A slightly higher proportion, however, said they faced charges of between 0.7 and 0.8 per cent. Nearly 14 per cent said they paid at least 0.9 per cent for DFM access.
Rose and North financial planner Hayley North says she is still “not convinced that they offer value for money”, so the firm does not use DFMs.
DFMs are facing a renewed challenge when it comes to fee income, regardless of whether you think their charges are excessive as they stand. Given most are paid based on a proportion of assets under management, market falls will feed straight into revenue out of the managers’ pockets as the size of the pool of funds they manage collapses.
While the persistence of advised assets should hold up well during market turbulence as planners encourage their clients to stay put and ride out the storm, DFMs dealing with direct private clients may face outflows from panicked personal investors, exacerbating the trough in revenue. The assets of direct clients who think they can time the market are far less sticky and more prone to rapid periods of flight.
On the plus side for the sector, nearly twice as many respondents to our survey rated service level/ease of relationship as “extremely important” compared to those saying the same about cost.
Similarly, 29 per cent said DFM performance was “extremely important”; less than the 48 per cent that said the same about service levels.
Manager selection was rated least important, below brand reputation and investment choice.
Many of these findings will reinforce the actions DFMs were taking before the Covid-19 pandemic to shore up their client base. Now they must take them on board to address the new landscape they face if they want to survive.
DFMs: Advisers either love them or hate them
DFMs are like marmite to financial advisers. But over the past few years we have witnessed more advisers incorporate outsourced investment strategies into their investment proposition.
In a commission-free world, advisers have much less interest in fund picking and manager selection. Instead, many now focus their service on tax and financial planning – where financial advisers can probably add most value.
Where advisers are using a DFM, this is often an embedded partnership. Advisers may well be selecting from panels of DFMs provided by their firms or network principals. Other advisers may segment their clients to select a DFM that is more suitable for their needs, for example, those providing specialist model portfolio services like ESG or Aim portfolios.
In our research with advisers, we see that charges and investment performance are the top selection considerations, even though these are areas where DFMs are finding it harder and harder to differentiate.
Some of the strongest DFM growth has been through their on-platform portfolios. Ultimately, this increases transparency and reduces cost for the client.
The lower the cost, the lower the barriers for entry for advisers to start outsourcing. Value for money is typically the top turn-off for advisers not currently using any DFMs. However, we do see some DFMs starting to combat this through ever-decreasing management fees, negotiated fund discounts and the adoption of segregated mandates to reduce underlying portfolio costs.
Andrew Ashwood is senior analyst at Platforum
Three resounding themes in the DFM world
The results of your DFM survey reinforce the three themes we have continued to see over the past 12 months :
- The DFM world continues to bifurcate – consolidation amongst the larger players and new, often in-house, DFM solutions appearing.
- Most DFMs have underperformed passive benchmarks for a number of well-discussed reasons including often a more defensive positioning of the portfolio (underweight US, underweight fixed income, underweight technology). Those advisers only focusing on investment performance will have or may have been considering changing to a passive strategy.
- Many advisers are accessing model strategies from DFMs rather than receiving a full discretionary service. The performance and costs of these model strategies are likely to be materially different to that delivered to clients receiving the full DFM service.
As a result of the above, the selection and ongoing monitoring of existing managers and their solutions is even more important at this time. Understanding the DFM’s investment style and proposition should help advisers manage client expectations on how the DFM should perform when markets are volatile.
It will be interesting to see how this pans out – in particular, the dispersion between active and passive managers during this quarter, which we believe will show the benefits of active DFMs.
Graham Harrison is group managing director at ARC Group