Ensuring that you include the right ingredients, and putting due diligence in context…

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Matt Ward, Communications Director at AKG, looks at the requirement for carrying out due diligence exercises when selecting or retaining DFM partners, suggests an overarching framework which can be used by intermediary firms to support this type of work and discusses why it’s important to contextualise and review such exercises.

The requirement for due diligence

It is in the best interests of intermediary firms to carry out robust, repeatable and recordable due diligence exercises when selecting or retaining partners for their business, including outsourced investment partner such as DFMs.

These exercises should be done to facilitate best practice within the intermediary firm and, crucially, to support the delivery of good customer outcomes. Furthermore, the regulator remains keen to see evidence of deeper and more engaged due diligence being carried out by firms.

In a market experiencing great change and challenge, due diligence will continue to play an important role and intermediary firms should be reminded that this is something which should be done when first identifying and selecting DFM partners, and then reviewed to support retention decisions on an ongoing basis.

Putting a due diligence framework in place

There are a variety of ways in which intermediary firms might go about their due diligence exercises and they should certainly be encouraged to tailor these to meet the specific requirements of their firm (from both an investment belief and a business model perspective) and crucially the needs of their clients/client segments.

In order to establish a robust and repeatable due diligence framework when selecting or reappraising DFMs, and to create a supporting audit trail, AKG proposes a balanced four-step process which can be tackled in any order and seeks to cover the following overarching areas:

  • Step 1 - Proposition research and analysis
  • Step 2 - Investment style and performance analysis
  • Step 3 - Operational capability and service delivery
  • Step 4 – Company-level assessment.

A suggested four-step framework

Step 1 – Proposition research and analysis

The nitty gritty research and analysis required to search the market and compare what's available in terms of the proposition(s) being marketed by DFMs to intermediary firms, i.e. What type of investment portfolio/service does the customer need? Who does what and how does it compare? Items may include analysis of:

  • Type of portfolio solution - Bespoke, Managed or Unitised Portfolio Service
  • Key features and composition of portfolio service
  • Associated terms and conditions
  • Cost of service versus the perceived value provided; transparency of charges
  • Accessibility of portfolio service via relevant product wrappers/platforms.

Step 2 – Investment style and performance analysis

When selecting a third-party investment specialist, an assessment of their performance credentials, and an understanding of their investment approach and style, will inevitably form part of the due diligence process for intermediary firms: 

  • Gain an understanding of, and be comfortable with, the investment approach and style
  • Seek out relevant past performance and request regular ongoing performance data
  • Match portfolio service to agreed risk parameters for customers
  • Monitor portfolio service performance against the objectives and parameters agreed at outset for the customer.

Step 3 – Consideration of operational capability and service delivery

Intermediary firms should also try to get a feel for the infrastructure in place within DFM businesses to support the ongoing delivery of portfolio services to customers and advisers. Items may include consideration of:

  • Resource, staff, team structure
  • IT systems, digital/tech development
  • Risk management systems and governance structure
  • Security of customer data and assets
  • Online/offline servicing capability
  • Integration with other relevant systems in the intermediary firm, i.e. CRMs, platforms.

Step 4 – Company-level assessment

Beyond the headline level of assets under management held, intermediary firms should seek to understand more about the DFM business that customer assets will be entrusted to by considering the following:

  • Business structure and senior management team
  • Core financials and capital position
  • Financial strength and sustainability
  • Operational approach, governance and risk procedures
  • Image and strategy
  • Intermediary distribution capability and support.

Contextualise against evolving market

Intermediary firms should also seek to contextualise these due diligence exercises, and key considerations for their clients and their business, against the backdrop of an uncertain economic, regulatory and political landscape, allied with an ever-changing financial services marketplace.

Reasons to review – how are DFMs responding to some of the key considerations/challenges faced?

  • Covid-19 – Approach to business continuity, adviser/client communications and service delivery, investment approach response.
  • MiFID II – Not quite a footnote yet. How did the DFM cope with delivering key MiFID II requirements?
  • M&A activity - The DFM sector is large in terms of the sheer number of companies operating in this space. For a variety of reasons, there will inevitably be consolidation, indeed we’ve already started to see some.
  • Sheer competition for business in the market for managed investment solutions ranging from multi-asset funds through to bespoke portfolio services.
  • Ability for DFMs to fund and drive through required enhancements to digital/technology capability.
  • MPS performance track record will come under more scrutiny as various solutions clock up more time in the market.
  • MPS pricing is an extremely competitive area and hence achieving cost efficiencies in the servicing of MPS business is a pre-requisite for survival here.
  • Quality of interaction and data sharing with relevant third parties such as investment platforms, SIPP operators and offshore bond providers.

The benefits of due diligence

By adopting robust due diligence processes, and by continuing to review and reflect on key associated considerations, intermediary firms will put themselves on the front foot with regards to sustaining winning relationships with DFMs.

Ultimately this will help adviser businesses and their partners to deliver positive customer outcomes and be able to better respond to change and challenge when it comes.

Find out more about AKG at www.akg.co.uk

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AKG is an independent organisation, which has specialised in the provision of assessment, ratings, information and market assistance to the financial services industry for over 25 years. A core focus is financial strength. In this AKG takes a specific and distinct customer perspective – that of the customer with ratings and reports designed and delivered for use by financial advisers.

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