12th December 2012
Would you prefer to hand over complete control of your investment portfolio to a professional including key asset allocation decisions or continue with an advised portfolio where your financial adviser must consult you about significant changes and fund switches?
This is a choice many investors using the services of a financial adviser could face in the next few years.
(There is of course another alternative in which you might seek out some information and guidance and perhaps use a portfolio planning tool to apportion your money across a range of funds yourself.)
For investors wanting someone else to take full responsibility for their investment decisions you increasingly have the option of choosing discretionary fund management.
In the past this was viewed as very much the preserve of those with hefty sums to invest, but is increasingly on offer to those with relatively modest sums. Certainly the minimum amount accepted by discretionary managers has fallen.
These specialist managers (or DFMs in industry parlance) say they will do all the legwork for creating and maintaining a portfolio that is specifically tailored towards helping you achieve your objectives under a pre-determined risk profile.
This compares to traditional financial advisers who put together ‘advisory portfolios’ for clients and must seek your permission when they want to make changes in the make-up of the funds even where economic and market conditions have changed significantly.
The discretionary route might also appeal to those who, perhaps, don’t have the time or knowledge to run their own portfolio and are unsure how to create a balanced spread of asset classes and review them regularly.
Finally it also avoids a large pile of paperwork and accounting for each transaction when it comes to the tax man.
Given that a typical diversified portfolio can hold upwards of 40 investments, a discretionary manager can ease this task by pulling this information into one document.
Of course, this means you have to put your faith in another person to make all your investment decisions particularly with regard to asset allocation. But given investors also do this when they buy a managed fund, this might be viewed as simply one step further.
Gavin Haynes, investment director at Whitechurch Securities which offers a DFM service, says: “The majority of financial advisers do not have the time and/or resources or expertise to look after their clients investments on a day to day basis, while also concentrating on their other core business activities.
“This has led to more and more advisers outsourcing the management of clients’ investment portfolios to specialist discretionary managers,” he says.
And a turbulent investment backdrop means that people want portfolios that are monitored more closely. Meanwhile, increasing regulation and the complexity and range of financial products makes looking after portfolios a more onerous task.
The impact of Retail Distribution Review (RDR), a big reform of to financial advice which comes into force in January is also likely to increase the use of discretionary managers.
In the current ever-changing climate clients are more likely than ever to question the advice received as they look to protect and grow their assets. So advisers are likely to have a relationship with a discretionary manager, or offer the service themselves as part of their business.
The RDR has several aims – to improve the investment management service to clients, to increase the standards of professionalism for advisers, and to clarify the way advisers are paid for their services.
As part of this process many advisers are concentrating on ‘advice’ which assesses, among other things, your attitude to risk, your financial goals and strategy for achieving them and your tax position. But having created this picture of you and established the parameters of your risk and investment needs, they may then outsource the investment decisions to a third party.
This could prove quite tricky for clients to get their heads around. In the past, your adviser has almost always outsourced some of these investment decisions to a fund manager or range of fund managers, but retained responsibility for fund selection and asset allocation. Now they may be outsourcing everything related to investment.
This may represent a sensible business decision for your financial adviser. It may keep the financial watchdog the Financial Services Authority happy too, but you have to decide whether it is also a sensible decision for you and your financial planning.
So is this ro
ute better than opting for an advised portfolio? It seems both have their benefits and pitfalls, depending on your situation and preferences.
Discretionary may prove ideal for those who want to hand over complete control of their investments to a third party and not really want to worry about it on a day to day basis.
Using this option, a manager can make changes to all portfolios quickly and easily – because they don't have to ask permission of investors – and it can also be at lower cost if changes are made in bulk.
But on the other hand, it could also prove pricey, with many discretionary managers charging, say, 2% a year of the portfolio value – on top of fund charges and other transaction costs. So check the detail before signing up.
Also, argues Patrick Connolly from AWD Chase de Vere, which offers an advisory service: “Discretionary services are often less personal and investors might get put into a 'one size fits all' approach so it might be less bespoke and personal to them.
“Those who do offer 'bespoke' discretionary services tend to be tactical asset allocators and often make lots of changes meaning lots of transaction costs. On the whole discretionary is more expensive than advisory – just look at fund of funds which is effectively a discretionary investment management service.”
The advisory route means investors get more say in what is happening, which is perhaps of particular importance to some in current conditions. Connolly says: “They have to agree to each individual change before it can be made so have much greater control. The downside is that changes can take longer to happen – especially if the adviser struggles to get hold of the investor or the investor dithers when making decisions or signing any relevant paperwork.
“Because of this advisory tends to lend itself to a strategic (as opposed to tactical) asset allocation approach where investments are held for longer, which then reduces overall costs.”
Danny Cox from Hargreaves Lansdown, which offers both discretionary and advised services, adds: “In the vast majority of cases, those who take advice do not sign up for a review service and once up and running, manage their own portfolios themselves.”
If you do opt for a discretionary service, you will need to discuss and decide what your attitude to risk is, and to determine whether you are looking for growth, income, or a mixture of both. The manager can then ensure the portfolio service they provide is in line with your needs.
However, remember that by choosing this service you are handing over all day-to-day investment decisions. That includes not only which funds or stocks to buy, but also the worldwide balance of your portfolio and the split between the different asset classes.
1) The first is probably the easiest. Are you prepared to hand over most investment decisions including those surrounding asset allocation to a qualified third party who is not your main financial adviser?
2) Are you satisfied with the costs you are paying in terms of advice and asset management. Actually this applies to any portfolio whether advised or discretionary. This should become a lot easier following the retail distribution charging reforms which will make such costs explicit.
3) Are you satisfied with the track record of the discretionary fund manager and the due diligence your adviser has performed on that manager’s ability to manage your money, adjust asset allocation appropriately, but also to make sure it always fits with your attitude to risk and your goals?
4) How ‘bespoke’ is the DFM service? We suspect that this will vary quite significantly. This is one of the interesting aspects of DFMs. As they reduce minimum portfolios sizes, are you really getting a tailored service? Some would argue that this isn’t possible unless you are handing over several hundred thousand pounds to be managed. Others think that it is possible to offer something very close to a tailored service to those with much smaller portfolios.
5) If this applies to you, how well adapted is your DFM to managing your money in the years towards retirement where you may wish to start taking income and where your biggest requirement may be capital preservation?
6) If you have a relatively small sum of money to invest, might you be better off in a multi-asset fund or multi-manager fund?
Mindful Money will be returning to this topic from time to time in the coming months. We suspect that the performance and services offered by DFMs will come under increased scrutiny. But done right, it may offer a means to meet your investment goals while allowing an expert to adjust things to a difficult economic and investment climate. But the more informed you are the better.