If your financial adviser uses a specialist discretionary fund manager (DFM) to select the funds in which you should invest, should this give you comfort or does it just add another layer of costs? Should you be worried if your adviser is selecting your funds without specialist advice?

To date there has been little public and comparable information to help you answer these questions.

The Collaborative Exchange, however, recently published the first SA DFM survey that sheds light on how some of the larger players operate, their fees, performance and research capability, the managers they use and their use of passive investments.

What is a discretionary fund manager?

Discretionary fund managers (DFMs), also known as discretionary investment managers (DIMs), are specialists who construct and optimise portfolios for financial advisers, leaving them to focus on giving you advice.

They research and select different fund managers as well as passive investments and then combine them optimally to target the returns you require depending on your tolerance for risk and whether you are growing your assets or drawing an income.

In choosing managers they should aim to combine managers whose styles complement each other so your investments are properly diversified and do not all do well or lose money at the same time.

The Collaborative Exchange’s DFM survey shows DFMs use three ways to run portfolios for you: they create either their own unit trust fund of funds, run a model portfolio of funds directly on an investment platform or manage bespoke portfolios for wealthier investors.

In a model portfolio a DFM can switch all the investors in that portfolio between funds using a single instruction, but must instruct each platform on which the portfolio is run.

Unit trust funds must comply with the Collective Investment Schemes Control Act, but Portfoliometrix CEO Brandon Zietsman says it is a myth that this adds to the costs as it is possible to run a fund of funds for a fee of just 0.8% a year.

A DFM running its own fund of funds is not restricted to the funds on the platform and can negotiate significantly discounted fees with any manager included in the fund of fund, he says.

When using funds on a platform, the fees are determined by the amount the DFM manages on that platform rather than across all platforms, he says.

Zietsman says a fund of funds allows a DFM to provide consistency in portfolios across all platforms and to manage fund switches efficiently and not only when platforms allow trades.

Switches in model portfolios can incur capital gains tax (CGT) for you, while as a fund of fund investor you only pay CGT when you disinvest from that fund.

Analytics Consulting MD John Eckstein says Analytics offers model portfolios and fund of funds depending on what advisers want, but will not launch a fund of funds unless there will be sufficient investment in it to justify the costs.

He says model portfolios allow investors to see all the underlying funds, whereas in a fund of funds disclosure is monthly on the fund’s minimum disclosure document.

Eckstein says the Financial Sector Conduct Authority is considering ways to ensure there is good reporting on both fund of funds and model portfolios.

The DFMs surveyed manage close to R200bn, which leads The Collaborative Exchange director Kevin Hinton to estimate that in total DFMs managed 10% of the R2.4-trillion invested in unit trusts and other collective investments schemes.

The use of these larger investment specialists is expected to increase here as it did in the UK.

Abbie Knight, a DFM consultant in the UK, told the recent virtual Investment Forum conference that the growth of DFMs in the UK was driven by increasing regulation and a realisation that DFMs could often run well-researched investment portfolios at a lower cost and with less administrative burden than advisers.

Knight says using a DFM gives advisers more time to spend on financial planning with you.

Though the survey is targeted at advisers and other investment professionals, it reveals some of the questions you should ask about the DFM your adviser is using or his or her failure to use a DFM.

1. Do you use a DFM?

Anyone who manages an investment portfolio for you must have a category II financial services provider licence, which requires more qualifications and experience than the category I licence most advisers hold.

Advisers with category I licences may contract with DFMs to manage your investments completely. Others who hold category II licences run their own funds of funds and in doing so some use DFMs as consultants.

John Eckstein, the MD of Analytics Consulting, says it is impossible to say whether it is better for an adviser to hand over completely or retain some control — it depends on what the adviser believes he or she can do to add value for you.

Brandon Zietsman, CEO of Portfoliometrix, says it is easier for a DFM to build economies of scale when it has full investment control.

Whoever manages your portfolio and selects funds for you, you should be happy that they have the appropriate skills and experience and that you are not paying double fees for financial planning advice and investment advice.

If your adviser runs his or her own fund, you should understand the rationale and be comfortable with his or her ability, support and professional indemnity cover.

2. Who is my DFM and why?

The survey reveals how advisers should check the ownership structure, culture and the size, experience and qualifications of the manager research team of any DFM they use.

Some DFMs are independent while others are owned by larger financial services groups and use or provide services to other parts of the group. For example, Glacier Invest uses Sanlam Investments Multi Manager for investments, and Absa’s DFM provides manager research for the fund “buy list” on Absa’s investment platform.

Zietsman says Portfoliometrix’s research is not for sale as effective, focused research without the distraction of doing a due diligence on funds the DFM will not use drives investment performance.

The survey reveals DFMs have different research processes and use different tools, including some of their own, to analyse portfolios and managers.

Your adviser should satisfy you that the DFM has a strong team and thorough research process that leads to good decisions on how managers are selected, combined and fired.

3. What fees am I paying?

If your adviser uses a DFM, it should negotiate lower institutional fees from asset managers. A DFM may also use of passive investments to lower costs to offset its fees.

Your adviser should be able to prove that you get good consistent, above-average returns after fees for using a DFM. If the fees are high, this creates a higher performance hurdle.

The Collaborative Exchange survey shows the DFMs’ total investment costs — including the asset management fees of the underlying funds — for portfolios in the key unit trust categories range from 0.77% for income portfolios to 2.67% for global equity portfolios (excluding the cost of the platform and financial advisers’ fee but including VAT).

On the popular multi-asset high-equity portfolios, total investment charges range from 0.98% to 1.64%.

SA’s first DFM survey identifies the big players

The Collaborative Exchange’s SA discretionary fund management survey included these eight large DFMs with the following assets under management:

·       Absa (R3bn);

·       Analytics (R42bn);

·       Boutique Investment Partners (R44bn);

·       Glacier Invest (R44bn);

·       MitonOptimal (R16.8bn);

·       Momentum Investment Consulting (R7bn);

·       Old Mutual Wealth (R1.9bn); and

Portfoliometrix (R38.8bn).

Two other larger players, Morningstar and Fundhouse, elected not to take part in the survey.

4. What after-cost returns have I earned?

If your DFM is offering its funds through a unit trust, you will be able to see what returns it earned relative to that of other unit trust funds in the same category. Comparisons may be more difficult for model portfolios.

The Collaborative Exchange survey shows a wide range of performance on a snapshot of portfolios in key unit trust sectors for periods up to five years.

Ask your adviser to show you how the performance you have enjoyed compares against not only the return you need — for example, five percentage points above inflation — but also how it compares with the top performers in the relevant unit trust sector.

Hinton says you should take care in reviewing returns without some reflection on the risks your manager took — the survey shows DFMs are generally earning higher returns but taking greater risks than the relevant unit trust category averages.

5. What investments does my DFM use?

The survey shows that DFMs prefer active managers and use varying degrees of passive — from 7% to 35% of their portfolios. Some use more boutiques than others and some use funds in their own group.

Eckstein says while non-independent DFMs may be under pressure to use funds from managers within their group, there may be benefits if those managers deliver good performance at low institutional fees.

Multiple layers of product with charges at every level are, however, not in your interest, he says.

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