DFM flows: Have we reached the peak?

By Daniela Esnerova

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The discretionary fund management space remains alive and well, but firms across the market saw a slowdown even before the Covid-19 crisis hit, Money Marketing research shows.

In our annual research, we had dived into annual accounts of ten leading DFMs of different shapes and sizes to get an overview of the DFM sector.

Discretionary assets continued to grow, but at a slower pace than in the previous year. The annual increase in total assets almost halved; median growth in assets under management was 6.95 per cent, down from 12 per cent a year before.

A note on the data: Figures are taken from firms’ latest audited annual reports. Reporting periods differ across the sample, and we have made a note where this is the case.

We reviewed assets under management, revenues, profits and profit margins, as well as year-on-year movements for those metrics. Where a group operates other services as well and does not provide a breakdown for its DFM arm in isolation, we took figures for the wider group. 

See table lower down this article for full results

Are we past the peak?

The latest reporting round largely doesn’t reflect the market mayhem that resulted from the coronavirus pandemic.

Brewin Dolphin, Rathbone Brothers and Quilter Cheviot retained their positions as largest DFMs by assets under management in our sample.

However, Rathbones almost caught up with Brewin in the period; its discretionary assets grew the fastest among the group as they jumped 16.1 per cent, almost double the sample’s average. In contrast, Quilter Cheviot recorded smallest increase its assets from the whole sample.

The greatest proportional jumps in revenue and profit were reported by the smallest firm out of the pack – PortfolioMetrix, based on figures for the whole group including both its UK and South African holding companies.

Top DFMs by discretionary assets:

1 Brewin Dolphin £40.1bn
2 Rathbones £39.7bn
3 Quilter Cheviot £24.2bn

Charles Stanley was the only firm whose assets fell, reporting an 8.4 per cent drop year-on-year.

Charles Stanley’s financial year runs to 31 March 2020, however, making it one of two surveyed firms whose latest accounts captured the pandemic-sparked fall in markets in the first quarter.

How DFMs have performed:

The only other firm whose accounts included the troubled first quarter of 2020, Tatton, reported an increase in discretionary assets, revenues as well as profit.

These increases were however largely driven by changes in the group’s accounting.

Tatton has an investment management arm, and also operates compliance and business consulting unit Paradigm Consulting and mortgage club Paradigm Mortgages.

For the latest accounts, the group moved the Amber Financial wrap platform, which was up until now accounted for under Paradigm, under Tatton DFM’s division.

PortfolioMetrix and LGT Vestra enjoyed a growth in assets of 43 per cent and 14 per cent respectively. However, these are consolidated figures for the whole group and they don’t show a breakdown of discretionary managed assets specifically.

Coming back from Covid

We will not fully understand the impact that pandemic had on DFMs’s financials until the next full round of financial reporting.

However, more recent trading updates from the firms in our sample show there was no hiding place in the first quarter of 2020 as DFM giants collectively took significant hits.

Rathbones’ £39.7bn in discretionary assets as at 31 December 2019 fell to £33.7bn as of April 5, representing a drop of 15.4 per cent.

Brewin’s discretionary assets, which stood at £40.1bn as at 30 September 2019, shrunk 11 per cent to £35.7bn as at 31 March, 2020, after £5.9bn was wiped off by investment performance.

Client books added through acquisitions in the period failed to outweigh the billions of assets wiped off by declines in markets and organic outflows.

Brewin’s half-year report included funds gained through the acquisition of Investec’s Irish arm, which brought £1bn to Brewin’s discretionary AUM.

Now integrated and rebranded, Brewin Dolphin Ireland is third biggest manager in the country.

Brewin’s assets bounced back again and stood at £40.6bn as at 30 June 2020, only marginally above September levels despite the acquisition.

Brooks Macdonald’s discretionary funds under management closed at £8.9bn at March 31 2020, down from £10.1bn at 31 December 2019.

This included adding a direct client book worth £0.4bn acquired from Cornellian Asset Management to its bespoke portfolio service in the period.

Trading updates for the quarter ending 30 June 2020 paint a clear picture of asset recovery across the sample, however, with AUM bouncing back to pre-Covid numbers.

Brooks’ AUM closed at £10.06bn at 30 June, the quarterly increase of 12.5 per cent driven by investment performance.

Covid bounce: Discretionary funds before, during and after the market crash

31/12 31/3/2020 31/06/2020
Charles Stanley £14.4bn £12bn £13.4bn
Brooks Macdonald £10.1bn £8.9bn £10.6bn
Brewin Dolphin £41.8bn £35.7bn £40.6bn

Since its financial year end, Charles Stanley updated the stock exchange for the quarter ending 30 June and reported that positive investment performance added £1.4bn to its total discretionary funds, swinging right back to over £13bn.

While the markets have picked up in, the pandemic shock will likely linger.

Tatton reacted with a cost-cutting exercise. It said it would go ahead with investment in future growth, but placed a moratorium on material capital expenses. Salary increases and bonuses have been frozen “until the Covid-19 situation unfolds”.

Elsewhere, acquisitions persist. Last month, Brooks announced it would acquire Lloyds Bank’s offshore wealth management business, which should add some £1bn to the international part of its business.

Adviser View

We don’t use conventional DFMs as the evidence shows that, like virtually all active management, it’s actually a detractor to market returns in the long run.

We only use a DFM for model passive portfolios so they can rebalance using their discretionary permission i.e. without the need to seek client permission every time.

I would say we are happy with this evidence based approach. Our clients have now firsthand experience of a market fall, which we’d been showing them on paper for several years. Our 50 per cent portfolio, invested in early 2018, is now showing a small positive return of circa 1 per cent on a report I ran this morning. This has been achieved by capturing market return, with tilts towards value.

I am certainly not crowing about performance, nor would I ever, but I am very pleased that the portfolios have done exactly what we told our clients they would do, and that’s far more important over the long term –  i.e how likely is it the client’s plan succeeds based on our expectations of returns and market falls.

David Bashforth is a chartered financial planner at Belmayne IFA

Moving and shaking

Quilter Cheviot maintained its position as one of the top DFMs by total AUM, revenue and profit. However it failed to make gains in line with the rest of the pack, as all of these metrics remained virtually unchanged pre and post-Covid.

Its total funds crept up by 3 per cent, hit by outflows. Quilter Cheviot recorded outflow requests of some £1.3bn in the reporting period. These partly relate to the 2018 exit of Cheviot Asset Management founder Michael Kerr-Dineen who left Quilter Cheviot to launch boutique Vermer Partners.

A host of Quilter’s investment managers followed Kerr-Dineen at the time. Clients and their assets joined them, once Quilter’s non-compete restrictions expired in the second quarter of 2019.

Quilter Cheviot’s revenue growth was the smallest among Money Marketing’s ten-strong sample of DFMs, coming in at 1.6 per cent, compared to overall average of 13.8 per cent.

Tatton, on the other hand, saw the second biggest jump in the revenue growth with 27.2 per cent, but this was partly due to one-off income in a form tax refund, rather than from organic growth.

Tatton received a total of £2.9m from the HM Revenue and Customs after the two agreed that its VAT is not payable on its managed portfolio service.

Growing pains

Brewin and Rathbones’ profits dipped, our analysis shows, as the biggest DFMs attempted to get even bigger.

In 2019, Rathbones completed the acquisition of the Scotland’s Speirs and Jeffrey, its largest acquisition yet. This was a major item in the company’s last accounts, as statutory profit before tax of £39.7m in 2019 came down from £61.3m the previous year, reflecting planned costs of £30.8m for the acquisition and integration.

By 1 October 2019, some 98 per of the funds gained through the merger were transferred to Rathbones. (The majority of assets were moved in the previous reporting year, and therefore did not contribute to the latest asset growth for our analysis).

Rathbones saw fixed staff costs grow some 13.5 per cent as a result of increased headcount. Following the Speirs integration, Rathbones planned out to cut headcount, however.

Brewin also stretched its fixed staff costs, mainly in its financial planning division.

Regulatory bills continued to drive up costs across our sample.

Brewin saw an increased FSCS levy of £3.1m, and Rathbones’ FSCS bill for 2019 was £4.5m, up from £2.8m a year before. The firm flagged that it reasonably expects this charge to increase by up to 45 per cent in 2020 based on FSCS announcements since.

In-house interrogation

Major DFM players are bullish on growing their in-house financial advice arms, apparently placing bets that this will lead to higher flows in the future.

Brewin Dolphin has continued to recruit for its 1762 advice business aimed at high-net worth clients. The 1762 team is now 44-strong, up from 17 at launch in 2018. Increased headcount in 1762 and salary inflation and accounted for £9.6m increase in Brewin’s staff costs.

These investments translated into higher flows into Brewin’s DFM. Private client discretionary funds make up more than half of Brewin’s total discretionary funds (£21.4bn out of £40.1bn).

An increasing proportion – now 60 per cent – of the private client inflows came from Brewin’s in-house financial planning division. Moreover, the firm said that flows from 1762 are starting to gain momentum.”

In the three months to June, Brewin’s financial planning income grew 15.3 per cent year-on-year to £8.3m.

Similarly, Charles Stanley has been charging up its in-house financial advice arm – and the bet has paid off sooner than expected amid the Covid-19 storm.

Charles Stanley has continued to make losses on its in-house financial planning – but that has come as a result of hiring more advisers, and financial planning revenues were up 19.2 per cent.

In its annual report, Charles said the division should move towards profitability once the planners are trained. It predicted that once new planners reach “full productivity,” the group should benefit from “greater asset inflows” and “greater share of wallet”.

Its latest trading update proves that the efforts have begun to bear fruits. Revenue from the financial planning division jumped 35.3 per cent.

Brewin has been diversifying its financial advice services to spread over different client bases. 1762 was meant to complement its non-advised bespoke investment service and serve clients with “more complex” financial planning needs.

On the other side of the spectrum, Brewin also grew headcount at WealthPilot – the wealth planning and investment advice service launched in 2017, aimed at clients with “simplified” financial advice needs. The firm is looking to continue developing both offerings.

How low can you go?

DFM fees are under pressure, however. A new entrant to the UK DFM market, Sparrows Capital, recently came forward with an MPS priced at 0.1 per cent per annum, capped at £20 per client per month.

Even clients at traditional DFMs like Cazenove’s saw their charges drop from 0.36 to 0.30 after the manager agreed with the HMRC that it doesn’t have to pay VAT on its MPS.

Several others are reviewing their VAT arrangements.

Expert View: Active or passive discretionary management – where is the value?

Cost is now coming under scrutiny. We’ve seen some consolidation, and I think we will see some more consolidation in this market now, particularly, as some of the smaller offices have been gobbled up already.

I think at the moment it is too early for people to make a call on Covid-19. You will get some of the immediate knee jerk reaction but I think everybody doesn’t really know yet quite how good, bad or indifferent performance has actually been from those managers, because we are still going through that change at the moment. I think in the next three to six months it will start to resonate and we will actually start to see who the winners and losers have been as people start to make their decisions.

In previous corrections in the markets, I can think of times when advisers turned around and found that what they thought they were getting is a service for their customers but what they actually got was a very different animal. When they compared it with some of the services in the market, they made moves. I think we’ll see a bit of this again.

The big one for me at the moment is cost. People got excited about the VAT situation that has been cited recently and how that is going to impact cost, but I do think for some advisers in particular, seeing services changing to passives will start to make them feel ‘if you’re dealing with passives, I could have built that’. There’s enough functionality on platforms these days to manage that, why do I want to come to you for a passive portfolio solution? What is it that you are bringing to the table that I can’t deliver?

Let’s be candid – a lot of time it’s been due diligence on different funds and asset types that has been the challenge for advisers. They have enough tools out there to deal with that from a passive perspective. For passives, I do wonder whether or not we will see a change in advisers’ thinking.

Due diligence and the insight when you are dealing with broader asset types and actively managed funds are where DFM solutions can – to my view – can really differentiate. I think some of them reshaping that will challenge the way some advisers are looking at them. We’ve seen enough of advisers having to turn around and cut their cloth accordingly. I don’t see any reason why they shouldn’t be expecting that also to be falling on the DFMs.

On the back of what we have been through, those guys that have been using active and they’ve actually demonstrated protecting assets to a degree will be the winners out of that. But those who have been using passives, if an adviser is comparing that with perhaps some of his multi-asset funds that they’re dealing with, he or she may feel that actually, I’m not getting best value for my customers.

Both sides of the service are moving closer together; DFMs have made no secret of the fact that they will look to grow advice functions to support their customers.

At the same time you’ve got other advisory firms that are looking at whether they come into the market, whether they’ve got the scale now to make this work for them.

There’s always been a challenge out there about at what point does the advice from one party end and the next party begin. I think we are starting to see that merge more. Possession of customer has always been one of the hot topics in distribution. We all talk about who owns the customer. Right the way though – be it an IFA, be it a DFM, be it a product provider – there will always be that conflict on who owns what in the food chain.

I think in this instance, particularly where there’s a more personalised service starting to appear, that tends to muddy the waters.

Rory Gravatt is a consultant at Altus

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