Investment outsourcing – where are we now?

This article was originally published in the Multi-Asset Review.

David Boyle, Researcher (Funds & DFM)

To be clear from the outset, I am using the dictionary definition of the word ‘outsourcing' - in this case, where advisers are using a third party to do what they used to do, or by their permissions could do. What this means in practice here is multi-asset funds or discretionary management.

In recent years, a proliferation of discretionary managed portfolio services (MPSs) have been offered to the retail market, but how do they stack up against their multi-asset fund counterparts? Perhaps a good starting point is to take a look at where advisers are currently placing their investment business.

As Figure 1 shows below, over the previous year, adviser firms on average split their investment business 68% towards discretionary solutions and 28% into individual funds run on an advisory basis. Of the discretionary business placed, 45% went the way of bespoke solutions and 55% the way of MPSs, with MPSs accessed through a platform coming out just ahead of those accessed direct with the discretionary fund manager (DFM).

Figure 1: Adviser Investment Business Split in 2018

Of the remaining 28% invested into individual funds, 60% of this figure (17% overall) are invested into multi-asset funds - that is, where both underlying security/fund selection and asset allocation are decided upon by the fund manager - and 40% (11% overall) are invested in single-asset funds, which indicates there are still a number of advisers running portfolios on an advisory basis.

Interestingly, when we dig a bit deeper into the figures, only 10% of the advisers surveyed placed all their investment business into discretionary solutions and just 2% placed all of their investment business into funds run on an advisory basis.

While there are some firms that are big enough, with enough resource and specialists still to run fund portfolios on an advisory basis, this would indicate that advisers have accepted - indeed, embraced - a new ‘job description' where they do the financial planning and asset managers run the money. That is quite a change in well under a decade. As long as the asset management sector continues to innovate and charge fairly for its services, this demarcation is very likely to continue.

Choosing an appropriate solution 

On the face of it, compared with multi-asset funds, the MPS looks to be the more sophisticated solution of the two options. After all, the client receives their own segregated portfolio - albeit in identical proportions to other clients in the same portfolio option - professionally managed by a team of specialists, with asset allocation selection, comprehensive reporting and portfolio rebalancing included in the service.

Many clients will like this, as there is at least a perception of a more personalised service over a unitised multi-asset fund - but is this perception a reality?

Multi-asset funds, as with MPSs, are professionally run by specialists - albeit within a slightly more efficient unitised structure. Fund managers do select asset allocation, do rebalance portfolios as a matter of course and do issue fund reports on a regular basis - although usually a couple of months out of date.

The main financial planning reason for choosing a DFM over multi-asset funds, or vice-versa, is the treatment of capital gains tax (CGT). While unit trust and OEIC structures benefit from CGT exemption from the sale of underlying funds, the downside is that, over time, a CGT liability could be building up - something the adviser will have to monitor.

Transactions within a discretionary management service become immediately liable to CGT - something bespoke managers should be aware of and take into account - and, as with the funds, advisers should be monitoring the situation with MPS portfolios that are standardised and will be traded regardless of any CGT issues. 

There is an overwhelming choice of both multi-asset fund and MPS solutions available but, while this is usually a good thing for the client, it can at times be a little tricky to navigate. The reality is, though, that many parallels can be drawn between MPSs and multi-asset funds in terms of what they offer the client.

Regardless of whether the chosen solution is an MPS or a multi-asset fund, the due-diligence considerations remain broadly similar and might include:

• A comprehensive risk assessment of both solution and client suitability;
• Risk assessment needs to be taken into consideration alongside potential returns. Ultimately, the client needs to achieve their goals;
• Assessing the DFM/fund manager in terms of investment skill and resource to deliver to mandate;
• Understanding the investment house view, style and ability to execute. The adviser has to buy into the investment firm's approach otherwise it will become an uncomfortable partnership when things are not going so well; 
• Regular monitoring to ensure: investments keep within their allocated risk parameters in line with a client's attitude to risk; the client continues to be rewarded for the risk taken; and goals continue to be achievable;
• All things being equal, due diligence should take care of any accusations of ‘shoe-horning' as long as it is carried out with individual clients in mind and is a continuous process.

Ultimately, the most suitable solution is likely to come down to what both the adviser and the client feel comfortable with. There are, however, suitability requirements that may lend themselves to one particular solution over another.

As Figure 2 illustrates below, sums invested into MPS solutions, both on platform and off (where the DFM has custody of the assets) are relatively large given that many of these solutions, particularly on-platform, were originally designed for clients with smaller pots enabling them to access discretionary services previously out of reach.

Figure 2: Where is the money going

Equally surprising is the average recommended fund value in multi-asset funds of £83,000. This is based on Defaqto's own analysis of the recommendation workflow on Defaqto Engage for single, risk-focused, multi-asset funds.

'Wealth hierarchy'

While we would not suggest that solution choice should be based solely on available investible assets, there does appear to be a ‘wealth hierarchy' developing - perhaps unsurprising, given a pre-Retail Distribution Review guidance paper (FG12/16) suggested it as good practice. In addition, there is arguably an expectation among many clients that, the more they invest, the better and broader the service they should expect.

Less of a surprise is the bespoke number, as clients suited to this type of solution will typically have more complex requirements in terms of the investment itself and the service surrounding it. Clients may, for instance, want to incorporate existing holdings into the portfolio, invest in individual securities or just be more involved in the process.

It would have been easy enough to end by concluding that multi-asset funds are more popular among smaller clients and vice versa with MPS - and indeed the data does generally support this view, even if the investment levels for both solutions are higher than expected. What we can see, however, is a wealth journey that seems to begin in multi-asset funds and potentially ends in a bespoke portfolio solution as clients move through their lifetime, their wealth accumulates and their financial affairs become more complex.

We would expect this general market structure to continue, but the battle in the coming years will be in the middle ground. The asset management sector has been great at designing solutions to take a client's money and accumulate wealth. Perhaps it goes against the grain to design great solutions for returning capital to the client, but the winners will be those that innovate and provide solutions for decumulation, whether they be multi-asset funds or managed discretionary portfolios.

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