What is behind the evolution of managed portfolio services?

This article was originally published on FTAdviser.com, on 09 January 2019.

David Boyle, Researcher (Funds & DFM)

Whether the solutions in this increasingly crowded market can all survive remains to be seen, but the signs are positive as assets under management are increasing across the board.

Defaqto has adopted managed portfolio services (MPS) as the preferred terminology for a portfolio of segregated holdings where all clients in a particular profile receive exactly the same portfolios and, crucially, are traded and adjusted, with a discretionary agreement in place, by the discretionary managers.

The evolution of MPS has been quickening, particularly over the past few years, and Defaqto has witnessed this as it has been collecting data on these solutions for the best part of a decade now.

Key to this evolution has been a shift in thinking from both advisers and discretionary fund managers (DFMs).

The days when MPS were seen as solutions for ‘mopping up’ clients with small pots to invest are largely a thing of the past, although some DFMs still offer solutions with very low investment thresholds, particularly when accessed through a platform.

Nowadays an MPS tends to represent a discretionary manager’s best thinking and they are viable investment solutions for clients with varying degrees of complexity and at most investment levels.  

At the time of writing, Defaqto holds comprehensive asset allocation and quarterly performance data on some 1,500 portfolios across 142 MPS solutions and from 64 discretionary managers.

Chart 1: The MPS evolution

The chart tracks the total number of MPS propositions on the Defaqto database over the past three years and breaks this number down into those solutions held in direct custody with the DFM and those available on a third party platform.

We can attribute their rise in popularity and continued traction in the adviser community to a number of factors.

Fundamentally advisers fall into two camps; those that manage their clients' money themselves and those that outsource. 

For those advisers lacking the wherewithal to physically manage client assets (or indeed preferring not to), the obvious solution is to outsource either to a DFM or a multi-asset fund where all investment decisions are taken by the third party investment specialist.

Outsourcing the running of client money is advantageous to advisers, partly because it reduces risk in their business and partly because it allows them to concentrate fully on financial planning without the ever-present worry of having to explain and justify the occasional wrong decision and falls in value, which can be a hindrance to a long-term client/adviser relationship.

More importantly, it is perhaps advantageous to clients that their assets will be looked after full-time by an investment specialist. This can result in a very positive shift in the client/adviser dynamic in that both parties are working together to find the best solutions.

The biggest hurdle

Perhaps one of the most notable developments on the evolution journey concerns the custody of client assets.

Perhaps as recently as six or seven years ago, DFMs appeared very reluctant to hand over formal custody of client assets to adviser platforms, preferring to keep control in-house, and as a result many DFMs were slow adopters of the MPS on platform business model. In a similar vein, advisers were equally concerned over losing their clients to a third party DFM.

The run-up to the RDR (Retail Distribution Review) in 2013 prompted advisers to review their businesses from top to bottom and this included a serious examination of how, and who by, client assets were managed.

This, together with the proliferation of platforms capable of hosting MPS solutions, proved to be a major catalyst. MPS, and in particular MPS on platform, gained serious traction in the market at this point. 

The rise of the platforms

The platform approach ensures that the client relationship remains with the adviser and not the DFM.

In most cases the DFM will not even know who the client is. With the day-to-day running of the client money in the hands of the DFM, the adviser is free to spend more time focusing on the client, while maintaining responsibility for the suitability and due diligence, all the while keeping sight of the assets.

While touching on platforms, a quick glance at Defaqto’s Engage data reveals that the average number of platform partners for a DFM MPS stands at seven. However, some MPS solutions are available on as many as 18 third party platforms. We can only see this accessibility widening further.

As evidenced in Chart 1, the ‘evolution’ of MPS has largely taken place on platform with considerably stronger growth here than in their direct custody counterparts.

With the vast majority of MPS portfolios consisting of unit trusts/Oeics and exchange-traded funds (ETFs), DFMs have been able to on-board their direct custody offering onto platforms without too much tinkering to existing portfolio models, while other DFMs have simply developed their proposition to include a platform version. 

However, do not assume that a platform version of a direct portfolio is the same. There may be different underlying holdings and there will certainly be a different charging structure.

With platform investment minimums starting from as low as £1,000, this has given advisers and their clients unprecedented access to discretionary solutions previously out of reach. 

Transparency is the key

Fast forward a couple of years and we are in the age of transparency.

When Defaqto started collecting data, not only were many DFMs reluctant to reveal their charging structure but they genuinely could not comprehend why we, and by inference advisers, would want to know.

While most DFMs are now fairly clear on the costs associated with their MPS solutions, there is still a little way to go before full compliance with Mifid ll is achieved.

But MPS solutions can, in the main, be compared on a like-for-like basis with their peers as well as fund of fund alternatives. 

Access to information, from charges through to asset allocation, means that other comparisons can be made.

Risk rating portfolios for instance, means that advisers can much more easily incorporate MPS selection into their workflows.

There is a temptation to greet all new regulation with resistance and cynicism, but for advisers previously suspicious of the opaque nature of DFM charging this represents phenomenal progress, and sends a clear message to the investment community that DFMs have arrived and are here to stay.

Spoilt for choice

The final guidance (FG 12/16) was issued in July 2012 and included the following actions for firms conducting replacement business: 

• consider the needs and objectives of its target clients when designing or adopting a central investment proposition (CIP);
• ensure that it is not ‘shoe-horning’ clients into the CIP.

In a nutshell this basically means the ‘one size fits all’ approach is not good enough.

In response to this, the scope of MPS solutions has broadened significantly as DFMs have taken on more clients and increased assets under management. 

The average number of portfolios available through each MPS solution now stands at 10. In addition, ranges have expanded beyond the standard low, medium and high risk. We now see ranges more granular in terms of risk, allowing more targeted judgements on suitability from advisers. 

Advisers can now expect to see income and growth ranges and perhaps even a passive range too.

Of the 142 MPS solutions Defaqto collects data on, 11 are classified as entirely passive, with a further 31 offering passive as well as active strategies. We expect the choice of portfolios to continue to grow.

Doing the right thing 

Ethical and environmental, social and governance (ESG) strategies seem to be gaining traction, and are looking to throw off the ‘niche’ label.

Clients with ethical requirements or those wishing to exclude specific investments for whatever reason have traditionally been steered down the ‘bespoke’ route, but these requirements can now often be met through an MPS portfolio.

At the time of writing, 23 per cent of all MPS propositions listed on Defaqto offered an ethical strategy, some with a considerable range. This is up from 19 per cent at the end of 2015. 

With investors of all ages becoming increasingly aware of social and environmental impacts, this is an area where we see potential for growth.

Hitting the target

Outcome based investing (OBI) is not exactly a new concept but one which we have witnessed a number of DFMs adopting.

OBI focuses on delivering a specific outcome aligned to the client’s needs and requirements - for example, a specific annualised return over a given timeframe. 

Clients may favour this approach above others as it is easier to tell if the DFM is delivering on the mandate. 

A crowded market

Defaqto continues to see a steady flow of new MPS entrants to the market and the vast majority of these new solutions have been designed with platforms in mind specifically for the adviser market, with some new entrants being the result of a collaboration between DFM and adviser firms.

To underline the direction of travel, more than 10 per cent of firms are only available on adviser platforms. 

Cost and scalability remain the focus for DFMs, and costs can really only be driven down further as further new entrants arrive, challenging established charging structures.

That being said, more than half of the firms have less than £1bn of discretionary assets under management (almost 10 per cent are less than £100m).

Whether they can all survive in this increasingly crowded market remains to be seen, but the signs are positive as assets under management are increasing across the board. 

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