Outsourcing investment: the pros and cons of using a DFM
Iain Duckworth (pictured), Jarrod Ellis and Stuart Doughty discuss whether the benefits of outsourcing to an experienced fund manager are outweighed by the negatives of losing control and, potentially, clients.
Chartered financial planner, Duckworth Alexander
Edinburgh-based Duckworth Alexander considered outsourcing shortly after it was established in January 2010, and undertook due diligence on Saltus, Brooks Macdonald and Williams de Broë (now Investec Wealth & Investment).
Benefits: Investment expertise
Discretionary fund managers (DFMs) have a great deal of investment experience and expertise at their disposal.
The potential gain from outsourcing is that you are using investment professionals with cutting edge technology for assessing financial risk and investment modelling tools.
DFMs can produce client reports with charts showing performance and how a portfolio is weighted, with recommendations for any changes based on economic and political factors, on a regular basis.
Outsourcing potentially removes some of the risk of running an advice business. By linking ourselves with a larger investment group, it could make our own business look more substantial.
Drawbacks: Conflict of interest
Ultimately, we decided the cons outweigh the pros. The remit of a DFM is to make money for their company and bonuses for themselves – and then returns for the client – so there’s a potential conflict of interest.
We know our clients personally: it’s not an abstract game in which the fund manager becomes insulated from the hopes, aspirations and fears of individual clients. We have to face them and explain why their investment funds are down, which thankfully hasn’t happened often in the last five years.
I’m pretty sure DFMs would have been caught out by the Tesco share price collapse despite the promises of being able to judge the economy and markets.
Financial planner, Delta Financial Management
Delta Financial Management, which has offices in Hertfordshire and London. It uses a panel of five DFMs: Brewin Dolphin, Brooks Macdonald, Canaccord Genuity, Close Asset Management and Whitefoord Investment Management.
Benefits: Dedicated resource
Having professionals whose sole focus is to manage money should be good for the client. An adviser sometimes has to wear many hats and may not have time to focus fully on portfolio management.
The DFM may have access to alternative asset classes, structured products and better research. High quality reporting on portfolios should be available.
Outsourcing allows advisers to demonstrate their independence by not using an in-house solution: you are more likely to sack an outsourced DFM than an in-house managed solution when performance is poor.
Outsourcing also frees up an adviser’s time, which can be spent on their core competencies.
Drawbacks: Loss of control
The main drawback is a loss of control. Outsourcing means advisers no longer have direct control over pricing, and if they are unhappy with the performance, moving a DFM portfolio can be cumbersome.
There may be no integration with an adviser’s back office system unless the portfolios are managed on a third party platform, which adds another layer of charges. The adviser will be giving away a potential source of additional profit, which may not be recouped in additional adviser fees.
We have overcome these challenges by negotiating lower fees where possible, using the output from the DFM to form part of a client’s reporting and using the resources freed up to spend more time with clients and develop a cashflow model.
Director, Centurion Wealth Management
Centurion Wealth Management, based in Bath, has used the services of DFMs since it was founded in March 2010. Its panel comprises Brooks Macdonald, Investec Wealth & Investment, IPS Capital, Quilter Cheviot, UBS and Waverton Investment Management.
We deal with experts who are dedicated to investment management. This allows us the freedom to sack or replace the investment manager, rather than the conflict of marking our own homework. Managers are measured against specific criteria.
Outsourcing allows us to focus on being financial planners, and not under the misapprehension that a financial planner creates value by selecting investment funds.
It gives us more time to spend with clients and plan their affairs in a tax-efficient and flexible manner as their plans change.
Our clients prefer the financial planner to be the gatekeeper that sits between them and their investment manager, and holds the investment manager to account. That can be difficult to achieve if you’re part of the same vertically integrated company.
The variability in the quality of service of investment management groups is the biggest drawback.
Investment management is becoming vanilla in terms of performance, risk and cost, but I don’t feel service standards provided to clients of professional financial planners are being replicated by investment managers and their teams.
Therefore, based on quality of service, the number of investment companies we can deal with is small, and becoming smaller.
Outsourcing is becoming less bespoke and more commoditised – risk is king. Clients are not being treated as individuals but more as numbers spewed out by a risk matrix.