In this edition of Technical Update Harry Kerr of Avalon Investment takes a look at the rise of the Discretionary Fund Managers (DFMs) in the run up to the Retail Distribution Review and explores the benefits of using a wrap platform.
Some planners and advisers view this route as an effective tool for them in terms of portfolio management and Mr Kerr believes this trend is likely to increase following the RDR in 2013.
He looks at the growth of DFMs against a backdrop of the RDR which aims to improve professional standards within the advisory community, alter adviser business models from all or part commission-based remuneration to fully fee based and improve the investment management process clients receive.
He warns, however, that all of this is a tall order and has inevitably forced advisers and planners to review their own propositions. He believes this will spur many to consider delegating investment decisions to a DFM in the future.
The role of the DFM is sometimes misunderstood but it must be made clear that they act on behalf of the client and leverage their expertise to maximise portfolio growth and protect against losses in the market.
Whether this is something they manage to deliver is something Mr Kerr will unravel in this article.

Outsourcing to a discretionary fund manager (DFM) has long been an effective tool for advisers seeking assistance in managing portfolios and this trend is only likely to increase under the Retail Distribution Review (RDR).
The RDR has been borne out of a desire to improve professional standards within the advisory community, alter adviser business models from all or part commission-based remuneration to fully fee based and improve the investment management process clients receive.
Such a tall order has inevitably forced advisers and planners to review their own propositions and will no doubt lead many to consider delegating investment decisions to a DFM.
The role of the DFM in the equation is clear; they act on behalf of the client and leverage their expertise to maximise portfolio growth and protect against losses in the market.
Unsurprisingly, the latter has never been more in focus than today as the ongoing stock market volatility that has wreaked havoc since 2008 forces many advisers to take a long, hard look at their business models and understand where their strengths and weaknesses lie and whether outsourcing to full-time, expert investment professionals would aid both them and their clients.
This is particularly important when advisers understand that managing investments through a period of economic turbulence could see them having to defend and justify their investment decisions to both their clients and the regulators.

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The benefits of a DFM
Given their deep understanding of the investment arena, DFMs possess the experience, confidence and ability to react quickly to sharp twists and turns in the market and have the skill to know which investment categories offer the best potential for returns in accordance with the clients' risk profiles. Furthermore, they sign a discretionary management agreement with the client, giving them the ability to make changes without seeking authorisation first, thereby making investments far more reactive.
Of course, it is not only the client who benefits from this proposition; undertaking the research and management of clients' investment portfolios is both a time-consuming and resource-heavy activity. As such, passing the process to a third party frees up advisers and planners' time to focus on building lasting client relationships and dealing with non- investment issues.
By utilising the resources and expertise of a full time professional investment team, whose sole job is to manage investments, the adviser can be assured that their client's portfolios are in expert hands and, from a regulatory point of view, the DFM will provide a consistent and auditable process.
In addition, outsourcing can prove to be a far more cost-effective solution for advisers than employing resources in-house.
At first glance, this would appear to be a win- win situation for advisers and DFMs but like many things, the benefits can prove to be a double-edged sword. With DFMs responsible for a great portion of the client's investment performance – and thus profits - the question must surely arise: is the DFM offering the client more value than the adviser?

The downsides
Traditionally, in order for the fund manager to carry out the transactions needed to run the portfolio, the client's assets are placed within the DFM's business. While this is unlikely to be experienced by Financial Planner, in the case where an adviser focuses on transactional business this could, of course, diminish the worth of the adviser in the equation, especially if clients connect the value of their portfolio with the DFM rather than with the adviser and start to question why they are paying for an adviser. This poses the danger that further down the line, the client could consider transferring their business to the DFM's own advisory arm.
On the other side of the coin, an adviser may feel that the DFM is failing to deliver the expected service and the client's assets would be better off with someone new. Given that the aforementioned assets are now held with the DFM, issues can arise around having to sell and reinvest assets, which could lead to inherent trading costs and possible tax implications for the client. A solution which is used by many planners and adviser to this issue is to use a wrap which allows the client's assets to be held on a platform in a nominee account and therefore offers the adviser the opportunity to stay in control of the assets, the relationship and the value proposition.
Much like DFMs are specialist investment managers, independent wraps are focused on delivering the best service and best value for both advisers and their clients.
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Platform solution
The platform market has been in operation for some 12 years now, though the majority of its growth has occurred only in the past two.
In the early years, the fund supermarkets began to attract volume assets but wraps struggled to take off with appetite for whole-of-market access restrained and new concepts struggling to find a foothold in the financial advisory market. As such, they tended to be the domain of the independent providers rather than the big name brands.
However, this changed with the realisation that the FSA was serious about implementing the RDR. Not only have advisers been forced to explore all avenues available to help them become RDR- compliant but there is a growing understanding of the value a wrap can bring to their business. By placing client's assets on a platform, in particular a wrap, advisers are helping themselves to manage the portfolio more effectively and protecting their own business interests.
A wrap enables valuation reports to be easily generated, switching of investments to be done quickly and efficiently and, with the right platform, done with no charge. In times of economic volatility, the latter could prove a huge boon to many advisory firms. Most importantly, it allows the adviser to retain control of the assets, but yet still be seen to be adding value by selecting and offering to the client the investment management expertise of the DFM. Rather than turn to their client and explain that they will be carrying out the Financial Planning aspect while the DFM will be undertaking the investment management operations, advisers will be a position to say that they have carefully selected a platform for the client's assets that allows easy access, switching and overall management of the investments, and has selected a specialist manager to run the investment side of the portfolio.
This way, the adviser has control over all aspects and can replace the DFM if it fails to be the best portfolio manager for its client's needs. By doing so, the adviser keeps the relationship with the client, undertakes the Financial Planning and tax work but crucially, is seen to be managing the investment process too. Additionally, reporting facilities can be white-labelled to the adviser, allowing clients to see the performance of their portfolios through their own portal and offering the best chance of achieving future goals. Using a platform solution gives the adviser greater security and confidence and importantly aligns itself with the principles of the RDR, in particular in reference to providing tangible ongoing service to the client.

Due diligence
Of course, selecting a platform solution and a suitable DFM for your client is no easy feat. There are several DFM services currently seeking to do business with the advisory market so careful due diligence should be carried out to ensure that they are the right fit for the business. The same applies to the best platforms in the market.
Discretionary investment management is all about selecting the right asset at the right time.
The beauty of a platform is its ability to hold or report on a wide range of assets, but it is absolutely essential that what they are and aren't able to do is understood. For example, not all platforms will hold the full range of mutual funds, or permit the use of ETFs, investment trusts and structured products. When selecting a service, advisers and planners need to be mindful of the range and independence the platform offers and whether they are willing to add new assets to those already held.
As advisers and planners continue to cast the net far and wide in search of different market situations and diversified risk, it is essential to have a broad range of options to hand. On the whole, it tends to be the independent wraps that offer this more wide-ranging service. They also tend to be agnostic in who they choose to work for, whereas some platforms will tend to lean towards preferred suppliers.
Clients' expectations are changing with the times and they now expect to receive a level of technology and ability that is akin to the services they receive in other walks of life; after all, a DVD can be bought at a click of a button, money switched from accounts by simply logging on. If the same cannot be said for their adviser, they may look to go elsewhere. That said, while technology is undoubtedly important, quality of service is what really differentiates one wrap or platform from another. This means not only providing the technology needed to efficiently run the operations, but a level of personal support that will aid adviser's relations and service towards their clients.
Going forward, I believe it will be this differentiation that will enable the platform market to accommodate both the larger players and the smaller, independent providers as the appetite for platforms grows.

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