Specialisms in discretionary fund management

Fraser Donaldson – Insight Analyst (Investments)

The job of the DFM is to manage money to a mandate. This may be a mandate set by the client or adviser (bespoke) or a mandate set by the DFM firm itself (managed portfolio service).

There are some circumstances that require particular investment capabilities beyond good strategic and tactical asset allocation decision-making.

Some examples of this would include:

• Ethical/socially responsible investing
• Sharia
• AIM portfolios for IHT planning (utilising business property relief (BPR))
• Taking on US clients

The first three on this list relate to the investment approach and may require additional due diligence on the firm's capabilities. The last requires specialist skills and knowledge.

Let’s take the last one first. We have all heard about the Foreign Account Tax Compliance Act (FATCA), but what does it all mean and what are the implications for a UK firm taking on US clients.

The introduction of FATCA has increased the  reporting burden of US citizens. First proposed in 2010, and then finally implemented in July last year after some revisions and working out agreements with countries abroad, FATCA aims to increase enforcement of US tax rules on its citizens and increase anti-money laundering monitoring.

Many institutions have complained that the requirements are onerous, but given the investigations and fines relating to tax evasion and Mexican drug-cartel money laundering, arguably increased monitoring and legislation in some form is desperately needed.

Many UK firms have spotted a niche for taking on considerable assets from US citizens abroad if they can cope with the reporting.

Shades of green

A portfolio option within a managed portfolio service is likely to have been designed to appeal to those clients who feel they should do something, but do not necessarily have a specific cause in mind.

These portfolios are likely to be a bit generic in nature and take a negative criteria approach, ie avoiding as much as possible areas that are considered to be ‘unethical’ such as arms, tobacco, alcohol and animal testing. These portfolios may not avoid these investments altogether, but may set a limit as a percentage of turnover. These solutions may well be termed ‘light green’.

For those clients that are going to be more specific about their beliefs, a bespoke portfolio would be the route to take. Discussion with the investment manager would elicit what types of investment to accept and what to avoid. Investing in companies that do not get involved in some sectors may not be good enough. Some clients may expect good positive action such as excellent employment rights and operating a carbon-neutral business.

Analysing the capabilities of the investment manager is crucial to due diligence here. While most bespoke managers will claim expertise in this area, the extent of this needs to be investigated.

For clients that have specific requirements and beliefs in a particular area, advisers may find themselves in the unusual position of deferring to the clients’ greater knowledge. Groundwork and due diligence to establish a credible shortlist are fundamental.

While many bespoke portfolio managers will be able to turn their hands to running an ethical portfolio, the rules on running a Sharia portfolio will have no different shades of acceptability at all. Sharia law is very specific and there is no room for compromises. There is no doubt that a specialist manager would be required to run a portfolio of this nature. Unsurprisingly, only two of the 75 discretionary firms that we cover run Sharia portfolios.

AIM portfolios for business property relief (BPR)

Quite apart from requiring a specialist knowledge of, and the resource to research the smaller company end of the market, there are several rules to obey for holdings to qualify for BPR.

While HMRC may provide written advice on a BPR-qualifying investment if requested, it is only on a case-by-case basis, and generally at the time that BPR is claimed. That is to say, only when there is the potential for an immediate IHT charge will HMRC rule under the law as to whether an asset qualifies for BPR or not.  

Once HMRC has assessed an application for BPR, investments that qualify (assuming they have been held for two years) can be passed to the deceased’s beneficiaries free of IHT.

It is clear that a specialist knowledge of the market is required. When advisers undertake due diligence in this area, in addition to client-specific questions, there are five fundamental questions that should be asked:

• The firm. History of success, including a record of BPR-qualifying failures. Research resource
• Experience of the investment team in the relevant market
• Performance history (in terms of following a mandate rather than absolute as many have low-growth expectations in return for lower risk). This would include payment of and level of income if this is important
• Diversification. Sector, themes, number of stocks
• Cost

Know who you're appointing

Before appointing a discretionary manager to run a specialist portfolio such as those mentioned above, ensure that they have the requisite experience, research capabilities, knowledge of the market and market understanding to take it on.