Is your discretionary fund manager selling out of its underlying funds too quickly?

21st May 2013

For investors who are using the services of a discretionary fund manager (DFM), new research suggests that DFMs are increasingly ruthless when it comes to sacking any underlying fund managers who under perform in the first year they are selected.

By and large, DFMs are used by better off investors to access an investment solution fully tailored to their investment goals and risk outlook. That is certainly how the theory runs. The DFM then selects a range of managers across different asset classes that meet their and indeed your requirements. But now consultancy firm CoreData in its DFM Research 2013 report says that DFMs are tolerating only 10 months of under performance on average before sacking a manager. Half would do so after only six months.

In a note, the consultancy says: “This is a worrying fact if you’re a cyclical manager or simply a manager that has hit a bad patch with one or two wrong calls. Despite fees and charges coming under increased scrutiny across all aspects of the industry, performance (89%) and perceived trustworthiness (92%) heavily outranked the importance of cost (64%) as a key factor in selecting a manager in the first place.”

The research also found that past associations with managers are important when it comes to the length of time it takes a DFM to hand out a new mandate. Nearly three in 10 (29%) DFMs admit to taking more than three months to award a new mandate to an asset manager they have had no past dealings with.

Craig Philips, head of UK and Europe for CoreData says: “This research shows that despite the increasing focus on costs, DFMs still view a managers’ track record as the key factor in selection, however, the honeymoon period is a short one with DFMs displaying their ruthless streak by not tolerating any prolonged period of underperformance. The figures also reveal the added pressure on those fund managers whose style is out of fashion as DFMs are unlikely to give them the time to come back into favour and make up for any potential losses.”

Despite the emphasis placed on underperformance, DFMs remain optimistic with their current roster of managers, stating satisfaction in the current relationship (81%), perceived trustworthiness (79%) and performance (78%) of managers within the company’s portfolio.

Other findings from the report include the fact that on average, DFMs have relationships in place with their manager for one to three years for their five biggest allocations. DFMs are also relatively optimistic about their present manager selection process. Seven in 10 (71%) DFMs describe their manager selection process to be very good in terms of its effectiveness and efficiency.

Mindful Money view

If you are using a DFM – and they are increasingly popular as recommendations from IFAs – it is wise to ask questions about what the investment process is, and indeed if you have an adviser, how he or she and your DFM will work together to make sure they are meeting your requirements in terms of investment goals and your attitude to risk. But this report raises another interesting question. Imagine if you as an investor found yourself buying a fund because you were convinced that the investment process worked well, you might sell out if you were disappointed by any under-performance. Yet that might not be the wisest course of action. Many funds can witness periods of under performance, particularly if they are taking a contrarian view to prevailing market wisdom. It can make sense to hold. It is a difficult decision and that is why is can make sense to delegate a lot of these decisions to a discretionary manager. But this research suggests there is a risk that even the DFMs might be falling prey to short-termism though it is difficult to known without having some individual decisions to test. We are not sure also whether such pressure to perform over a short period – and the six months that some of them are waiting for feels like a short period – helps the underlying fund manager. CoreData themselves say as much though their largest holdings do tend to be held for longer. If you are using a DFM, we think it may be worth asking how often your DFMs change underlying managers and in what circumstances and if they worry that sometimes they are too swift to judge. If you a buying something promising discretionary management, we think you are more than entitled to ask some searching questions about this.

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