Platforum: Why has outsourcing to DFM model portfolios plateaued?

Miranda Seath

The trend towards advisers outsourcing more and more of their investment solutions is slowing down. At Platforum we spotted this last year and it seems to be continuing. The question is: why this is happening?

It is hardly surprising that the discretionary fund management industry has woken up to the threat of stagnation and has decided to launch an “alliance” to sell the adviser community on the benefits of outsourcing. Five of the largest DFM firms are now cooperating in their marketing to advisers and more may be joining the alliance in due course.

DFMs thought they had struck pay dirt in the adviser sector during the run-up to the RDR and then in the following couple of years.

The proportion of clients’ investment assets managed by DFMs leapt up by a third between 2013 and 2015 – from 18 percent in 2013 to 24 percent in 2015.

Extrapolating that rate of growth, one might have expected the proportion of adviser assets under the care of DFMs to reach well over 30 per cent by mid-2017.

In fact, it was just 26 per cent in November 2016 and it might reach 27 per cent in the middle of this year, assuming the current trend continues.

So what’s going wrong for the DFMs? Why aren’t they hoovering up adviser assets as they might have expected?

DFMs generally offer two main types of solution to advisers: bespoke solutions and model portfolios. With bespoke portfolio management solutions, investments can be tailored – more or less – to meet clients’ specific needs, circumstances and existing investments.

Fees for these services are often in the region of 100 basis points, but may be lower, especially for large clients.

Model portfolios are typically more-or-less standard offerings differentiated by their risk profiles and typically a good deal cheaper for clients with fees upwards of 15 basis points to 50 basis points or more depending on the DFM.

DFMs are already feeling competitive pressures and their fees are on a generally downward trend. Of course, DFM fees are just one link in the value or cost chain, which, with the combined provider, platform, DFM and adviser charges can easily exceed 200 basis points.

Advisers are increasingly aware of the need to keep a cap on overall costs, because of the long-term impact on investment performance and also growing client perceptions of the importance of keeping costs down.

So why is the growth of the DFM market seemingly running out of steam? There are several reasons.

Larger firms are buying up smaller advisers and bringing their clients onboard to their in-house, vertically integrated, managed investment solutions. On average, about a quarter of those clients will have been in DFM managed portfolios.

Some medium-sized adviser firms have observed the biggest adviser businesses apparently making fat profits from their vertically integrated structures and have decided to bring back their investment in house.

They hire their own investment expertise or buy it in from research firms. Sometimes DFMs get to be the “in-source” suppliers; sometimes they don’t.

The profits for these advisers may be illusory – or at any rate may take longer to achieve than they expect – but this is a growing trend.

Provider-led solutions are many and various and also have their attractions for advisers compared with DFMs.

In some cases, it is the cheapness and efficiency of the service – think Vanguard. In other instances, the provider has a compelling story, for example Dimensional.

A surprisingly high proportion of advisers believe they are reasonably competent at running money themselves. No doubt some of them are – even on an advisory basis.

If DFMs are to regain their growth momentum in the adviser market, it may be that the new DFM alliance will have to persuade more members
of this sector of the virtues of disciplined, expert investment from portfolio managers who can be sacked if they don’t perform.

Miranda Seath is senior researcher at Platforum

Platforum is running an event for senior fund selectors touching on some of these issues. The Investment Strategy Forum on 30 March is invitation only. If you are interested in attending, please contact Miranda.seath@platforum.co.uk