DFM on a platform – an accident of history?

Fraser Donaldson – Insight Analyst (Investments)

Defaqto’s adviser tool, Engage, currently covers some 190 discretionary propositions from 82 discretionary firms. 113 solutions are Managed Portfolio Services and interestingly, 61 of these are available on adviser platforms. It's a sign of the times that there are more MPS solutions available through a platform than there are direct with the discretionary managers. A relatively recent phenomena, 80% of the MPS on platform propositions have been launched since the beginning of 2010.

There is essentially a three stage process to go through, leading to a client investing in a managed portfolio service administered on an adviser platform:

• A decision by the advisory firm to outsource the management of investment portfolios to third parties, and that could be through funds or segregated portfolios
• Preference for segregated portfolios through a discretionary management service over unitised funds
• Preferred distribution channel. Ie a preference of adviser platform administered over direct with the discretionary firm

The curious thing about these three decisions is that they have very little to do with client suitability.

A firm’s decision to outsource management of investment portfolios is likely to have been taken with the client very much in mind, however reluctantly it was done. There will be very few advisers that will have the resource to manage client portfolios to the exclusion of all else. Of course, the responsibility of managing the portfolio to the agreed or identified mandate will pass to the third party investment manager, which will suit many advisers.

There is an element of suitability around whether a segregated portfolio is preferable to a unitised portfolio as each is treated differently for tax purposes. For unitised portfolios, trading can take place within funds without any immediate liability to CGT, although gains do roll up and liability can occur once units are sold. For segregated portfolios, potential CGT liabilities can occur every time there is a trade.

Both sides would argue the benefits of their own positions, discretionary managers perhaps having more of an opportunity for CGT management, fund managers suggesting that very few clients would ever be subject to CGT. The latter may have a point, but this difference should be considered, and it's unlikely that any CGT management would take place in anything other than bespoke portfolios. For managed portfolio services, it's more likely a situation that the adviser will take on board.

Finally, a managed portfolio service is available either through an adviser platform or direct from a DFM firm.

So, what has brought us to this point? It's true that DFM’s have had to accept that to successfully break in to the retail market their propositions would have to be made available on adviser platforms. The reason? Well, a significant amount of adviser client assets had already been moved to a platform long before the DFM industry decided to market seriously to the adviser. For many advisers, the platform will be integral to their investment offering. The story may have been different if DFM’s had begun to market through advisers perhaps 10 years ago, rather than five.

Today there are still DFM firms that steadfastly refuse to offer their solutions on a platform, reluctant to give up custody of assets. Equally, there are those that only make their discretionary solutions available through a platform. This latter category is the fastest growing with 25 out of the 61 we cover only available through a platform.

So, what are the differentiators between investing via a DFM compared to through a platform?

• There is no necessity for the DFM to have visibility of the underlying client. Some advisers will prefer this if they are, perhaps irrationally, nervous about their clients being poached
• If the DFM has no client visibility, then responsibility for suitability of the investment initially, and ongoing, falls squarely on the adviser’s shoulders. This does beg the question on where responsibility lies should the adviser ‘shut up shop’ or retire
• Almost all administration and service aspects will be taken care of by the platform. This means that a DFM’s reputation for service is largely irrelevant. It also means there is little room for flexibility of service, unless that flexibility is facilitated by the platform
• Administration and service provided by the platform is likely to be embedded in the adviser business, so accessing through a platform will achieve consistency of approach
• While the goal will be to select a service that will deliver on client expectations and needs over time, should things not go well, it will be a lot easier in administrative terms to switch from one service to another if both are available on the same platform, than to switch when both are held directly with the DFM
• It's possible that DFM’s may have to make some compromises when making their portfolios available on a platform. Some investments or fund share classes that a DFM could access direct may not be available via a platform. It's worth comparing direct portfolios with platform portfolios to see if there are significant differences. Taking this to the extreme, it's possible that a DFM manager may be running a slightly different portfolio on each platform that the service is available on
• The compromise may also extend to the range of portfolio options on offer. Some specialist or less popular portfolio options within a service may not be accessible through a platform, so this also needs to be borne in mind when considering the whole client base
• There may also be trading differences. A DFM, once a decision has been made to change a holding, will probably action this immediately. A platform may take longer, perhaps aggregating all deals over 24 hours. Whether this makes a significant difference over the longer term is a judgement call for the adviser, but should be factored in to any due diligence
• Charging structures will be different. The charge by the DFM should reflect the fact that their principal responsibility is the portfolio management and that most, if not all, admin, service custody aspects are undertaken by the platform. In other words, the DFM charge will be (or should be) significantly lower than the direct alternative. The platform charge then becomes important in judging costs
• It's usual, although not always, that a DFM will incorporate trading fees in its annual management fee. As the platform will be undertaking trading, it's wise to see if trading costs are additional to the platform fee
• Tax wrapper accessibility may be important, so if accessing through a platform, the suitability of the tax wrappers available, if required, would also be a consideration

Conclusion - The Outsourcee becomes the Outsourcer !

Almost by definition, a portfolio sold by the DFM directly will not be precisely the same as the equivalent distributed through a platform. In essence a DFM is (sometimes reluctantly) outsourcing elements of service, administration and custody to the platform. It's up to the adviser to decide through due diligence and research, whether or not these differences are significant.

As mentioned, a number of the MPS on platform services have only been launched in the last couple of years. This being the case, sometimes the only option is to look at the directly available equivalent for such things as performance. In the majority of cases this will be more than adequate, but advisers still need to be aware of, and take in to account, the potential differences.