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IFA guide to Discretionary Fund Management (DFM)

In a period of such market volatility and uncertainty, many advisers will be thinking again about whether they want to continue to undertake the management of their clients investment portfolios. Do they have the resource, experience and time to do their clients justice. Many already have outsourced some of their investment process to the multi-manager, and will continue to do so. But will this be acceptable to the ‘bigger’ clients who will perhaps be expecting more? Putting their faith in a DFM may be the solution for some, but how should you go about selecting one of the hundreds that there are out there? This short guide is designed to help the adviser in their decision making. Where do I look ?DFMs do not advertise as widely as the product providers you are used to, and to a great extent rely on reputation to attract business.

• The APCIMS (Association of Private Client Investment Managers) website lists many investment managers, and there are some basic sifting facilities to help you get down to a short list.
• If you are part of a formal or informal network of advisers, see if you can get a recommendation from one of your peers.
• Some products such as SIPPs and offshore bonds run panels of DFMs, and it is likely that some basic due diligence has already been done on these.

EligibilityThere are some basic facts that you need to find out, to see if potential DFMs are going to be suitable for your client base.

• Minimum investment. Not always cut and dried, as there may be flexibility if there is the prospect of many new clients, or on an individual basis if there is the prospect of more assets ie through extended family or potential inheritance. May be worth negotiating if you like the company but their stated minimum seems a little high.
• If coming to a DFM with existing portfolios, will they take these on and trade in to their own style over time at reasonable dealing costs, and if they do this how do they treat, if at all, possible Capital Gains
• Will they manage portfolios that are tax wrapped, such as bonds and SIPPS. DFMs like to retain custody of the assets and this is not always possible with some tax wrappers and providers. Some may offer advisory services without the need to retain custody of the underlying assets.
• Will the company run portfolios to a requested benchmark.
• Does the DFM use securities that are suitable for your clients eg will they run portfolios of collectives only

Cost

• Both parties will want to be remunerated. What is the proposed split of commissions and fees. Does the DFM operate a sliding scale of fees based on assets under management, and does that sliding scale fit in with your own remuneration structure?
• Do they deal with fund managers on institutional terms? If they do, this means that adviser and DFM can get paid with less detriment to the client.
• If they do not have access to institutional funds, can they demonstrate that they deal with fund managers on favourable terms ie no initial charge and perhaps rebates on annual charges. Ask for examples. Dealing at NAV plus a fraction of a percent (say 0.25%) initially would be reasonable. Getting close to 50% rebate of amc would also demonstrate some negotiating skills.
• Any other costs such as set up fees, exit fees and transaction charges ?
• Find out what the cost of transferring stocks is. In the event that your chosen DFM does not meet your requirements and you want to switch to another, you do not want to be heavily penalised with transfer costs.
• Are all reports included in the fees? Does the client have to pay extra for tax reports (CGT and Income). Is there additional cost to client for ad-hoc valuations for instance?

Service

• Will all clients receive the same service level, regardless of assets under management? Eg smaller portfolios get multi-manager, then progressing up to individual collectives, and for the larger clients some direct equities/fixed interest or hedge funds. Similarly, would smaller clients get an off the shelf model portfolio, with larger clients perhaps getting something a bit more bespoke. Establish the parameters for these.
• Would the DFM be prepared to meet clients, make presentations to fellow advisers, help with marketing material, possible even white label the service. Again, establish what level of business would be required to get what level of service.
• Would each client have a named manager? If not, would there be a dedicated help facility for the adviser? Will they impose restrictions on contact?
• What reporting will the adviser expect? Client reports, market commentary, fee statements, tax reports. And how often?
• It would probably be a good idea to establish a formal progress meeting schedule where concerns on both sides could be aired and hopefully resolved eg performance on the part of the DFM, and perhaps administration on the part of the adviser. Preferably to be attended by senior parties on both sides. Twice a year would be sufficient. The likeleyhood of establishing this process will increase depending on business placed by the adviser.
• Do they have a published service charter

Investment ProcessIf you are considering placing large amounts of your clients assets with a DFM you need to be comfortable with the way they are proposing to run your clients money.

• Ask about their approach to risk. Are the DFMs themselves monitored in their actions and decisions? Are they given a risk budget to work to, and how is this applied. If model portfolios are used, ask them to explain their risk approach to each. For instance, how far can they stray from their benchmark?
• Ask them what their investment philosophy is, and a brief explanation of their process? How do they get from a universe of perhaps tens of thousands of funds, down to a small portfolio of funds? What process do they have in place for monitoring funds they invest in? Is there a strict sell discipline?
• Then ask them what help they have, either in terms of technology or personel, in achieving this process.
• Find out about size of firm & ownership and judge whether they really have the resource to deliver the process they outline?
• Big firms of DFMs will have resource, but smaller ones may well be more fleet of foot and flexible
• Ask for a model portfolio from one and two years ago, as well currently, and perhaps do some basic research on the success of these portfolios

If you can be satisfied to the answers to all the above questions you will be someway to establishing a manageable shortlist. However, almost as important is your own feeling on how well you think you will be able to work with the DFM. Hopefully, your chosen DFM will effectively be a business partner for many years, so liking and trusting them from the outset is an important factor, and this will be down to your own gut feeling. Find someone who wants your business, not gives you the impression they are doing you a favour, and you will be off to a good start.