Adviser and DFM relationship should be at arm’s length


Roland Gräbe | Head | Discretionary Fund Management | Old Mutual Wealth | mail me |

Financial advisers need their wits about them when choosing a discretionary fund management (DFM) partner and should undertake a comprehensive due diligence process to differentiate between the ‘mixed bag’ of companies they may encounter in this space.

Advisers are warned that they will encounter many financial services providers (FSPs) that have cleared the low hurdle of obtaining a Cat 2 license to operate as a DFM, including ‘top tier’ asset managers, specialist DFMs, small business owners, and even individuals.

A major growth catalyst for the DFM industry

DFMs offer investment services to both independent and tied financial advisers, so that these intermediaries can in turn place their clients’ funds into cost-effective and risk-and-return appropriate model portfolios, while focusing on their core service – advice, without needing to worry about the investing portion within their practice.

The South Africa Retail Distribution Review (RDR) – a set of regulatory proposals that first headlined in 2014 and have since gradually been implemented in the regulation of financial services – has been a major growth catalyst for the DFM industry, which now comprises more than 50 managers, making it difficult for financial advisers to choose the right DFM for their practice.

As a start, advisers should identify DFMs with significant assets and scale and the capacity to perform most of the requisite fund management functions in-house. Your choice should then be based on three pillars: service, price, and performance – with the latter two pillars being closely related.

Price and performance have a predictable relationship in investing, in that expensive solutions typically underperform low-cost solutions over the long run. It is also worth noting that DFMs that outsource important functions such as manager research end up adding unnecessary costs to the value chain.

The win-win for the DFM, financial advisers and investors is a solution that is more attractively priced than a typical balanced fund, with comparable investment returns. This victory is achieved by sticking with a DFM that strikes a balance between quality asset management and lower-cost investment strategies.

Financial advisers can test a manager’s investment credentials by examining publicly verified track records to determine if portfolios are being managed in line with the stated DFM’s investment processes.

The collaborative exchange

The collaborative exchange – which offers independent strategic advisory and retail implementation strategies for asset managers, investment platforms, and wealth managers within the South African retail landscape – also publishes extensive data on local DFMs, making it an excellent consultative platform for financial advisers’ research.

The exchange provides a comprehensive overview of the main players in the industry, as well as a wealth of information about each DFM; further research can be done by making contact with DFMs that suit the needs of the financial adviser and exploring their offering.

It is important for financial advisers to align the investment philosophy and approach of their preferred DFM with their own views on investments. DFMs, just like asset managers, can experience periods of volatility, during which time trust and mutual respect between the adviser and DFM become important. This trust relationship ensures that clients’ interests are best served.

Trust is further established by avoiding relationships that create conflicts of interest between parties – DFMs that pay fees to advisers or deals that commit the adviser’s client book to a DFM are best avoided. The relationship between adviser and DFM should be at arm’s length so that a DFM can be fired if it is not delivering to expectation.

In conclusion

Although the DFM market is complex, it is unlikely that independent DFM assessment services will emerge to help advisers with the due diligence process. It would anyway be unwise for DFMs to pay to participate in such a service. The ‘pay to play’ model has been used in many parts of the investment industry and brings about significant bias and conflict of interest.

My advice to financial advisers is to start slowly with one or two DFMs and take a long-term approach to determine if clients’ needs are met by them. A DFM should however consider the financial advice portion of the adviser’s practice as more valuable. This can be achieved by saving the adviser time, helping him or her grow the practice, and by making client engagements more efficient.

DFMs can further support the adviser through increased investment knowledge and professionalising the investment process itself.



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