What is Discretionary Fund Management?

Fraser Donaldson – Insight Analyst (Investments)

Terminology has always been one of the difficulties to overcome in the Financial Services industry, leading to potential mis-understandings at best and possibly poor client outcomes at worst. Defaqto publish this DFM newsletter, in part, to help clarify what is going on in the market in a clear and easy to read way.

It is always a good idea to occasionally remind our clients and readers what we mean by Discretionary Fund Management (DFM). The first thing to note is that we have adopted what we believe to be the industry accepted norm as the generic description.

We are aware that the FCA uses the descriptor Discretionary Investment Management, but quite apart from the rather unfortunate acronym, we do not believe this has yet been adopted across the industry. We will obviously keep this under review.

Now, as far as Defaqto are concerned, what do we mean when we classify a proposition as DFM? While there are always variations on a theme, we believe there are essentially three distinct types of DFM proposition:

• Bespoke
• Managed Portfolio Service accessed direct from the discretionary managers
• Managed Portfolio Service accessed through a platform

We have our own definitions which we use internally when there is any doubt as to where a proposition should sit, which we thought we would share with you:

Bespoke:

The Portfolio is constructed specifically for a client, within a segregated nominee account, taking into account their individual preferences and needs, in terms of outcomes and risk budgeting, typically from a full spectrum of investments.  Direct contact between the client and their investment manager is expected. Ancillary services should be available.

Managed Portfolio Service (direct from the discretionary manager):

The Portfolio is structured, within a segregated nominee account, for different client segments with clients matched to predetermined portfolios, should their preferences of outcome and risk budgeting match. Clients choosing a specific portfolio will get the same portfolio – there is no investment tailoring for the client.  A full suite of investments may not be available in these standardised portfolios. Direct contact between the client and Discretionary Fund Manager can be expected as the funds are held by the Discretionary Fund Manager. Ancillary services could be available.

Managed Portfolio Service on a platform:

Portfolio is structured, within a segregated nominee account, for different client segments with clients matched to predetermined portfolios, should their preferences of outcome and risk budgeting match. Clients choosing a specific portfolio will get the same portfolio – there is no investment tailoring for the client. A full suite of investments will typically not be available, and will be limited by what is available on the third party platform. The client is not expected to have direct contact with their investment manager.  The funds will be held on a third party platform that is responsible for execution and custody.

The above descriptions are what we at Defaqto use to classify each DFM proposition.

There are propositions out there which highlight a bespoke service, but it is the structure of the portfolio itself we focus on. If it is standard portfolio (ie all clients get the same) this would still fall under Managed Portfolio Service, no matter the extent and flexibility of the service offered.

Equally, there are propositions out there where the core of all portfolios are standard models, which are adjusted around the edges to suit clients individual circumstances. Sometimes called Tailored Portfolios, even though numbers of portfolios will look very similar, we would still classify these as bespoke as there is still an element of client tailoring.

In our experience, the majority of bespoke propositions out there being distributed through advisers are of the tailored variety. There are very few that start with a blank sheet of paper and built from the ground up.

There is a fourth category of proposition which we ought to mention. There are a number of discretionary managers that offer funds, which reflect the philosophy, investment process and portfolios of the segregated portfolios they offer. They are still funds, but we have called them Unitised Discretionary Management (UDFM) . Our definition for funds which we view as UDFM is:

Portfolio is pooled (ie. not segregated) and is contained within a unitised fund structure which is a fund in legal structure terms but is managed by a Discretionary Fund Manager. The aims of these funds are typically to mimic or mirror the managed portfolio solutions offered by that DFM, but with the advantage of lower investment requirements, making them available to a wider range of investors.

The above has been Defaqto’s stance on the structure of the market for many years now, but as always we are interested in any views and our opinions our readers have, so please feel free to get in touch