Outsourcing investment: the four key considerations

Will your clients be happy paying adviser, manager and product charges?

With the RDR deadline approaching, many advisers are opting to outsource the investment function.

One solution is to appoint a discretionary fund manager (DFM). However, there is concern some advisers are making this decision too quickly and not considering the risks.

So what are the key considerations?

Charges

What to do about cost. A post-RDR world will mean transparency of fee structures and this will make for some interesting developments, says Kim Barrett of Barrett Financial Solutions.

He believes clients will not be happy having to pay adviser and manager charges before product fees have even been considered.

“It is not an attractive concept and, when you sit down with clients and talk pounds, you will get some quite interesting conversations."

Meanwhile, Martin Bamford, managing director at Informed Choice, claims many DFMs are not worth the cost.

“There are plenty out there who offer little more than a series of model portfolios, yet charge expensive fees," he says.

"IFAs will want to ensure their chosen DFM offers something suitably bespoke and has a process in place to support this."

Liability

The biggest problem with outsourcing, according to Magus Financial Management's Dante Peters, is relinquishing an element of control over your clients' capital.

He says, in his experience, DFMs will run money the way they think appropriate, while the adviser still carries the burden of liability.

"If the client loses money, there is the potential you will end up with facing a claim, especially if you have not been keeping an eye on what the manager is up to,” he warns.

Barrett agrees: “Far be it from me to question a DFM, who should know more than me. But what if they are not very good? What if they pick investments that are clearly wrong?"

Duty

Some advisers maintain making investment choices on behalf of clients remains an adviser's realm.

Blair Cann, senior partner at M Thurlow & Co, has never felt the need to outsource to a DFM. “It’s part of an IFA’s duty, and so that is what I do,” he says.

Cann is concerned the detachment between a DFM and client would make the service too generalised and impersonal.

As Peters discovered, this could lead to problems with definitions and risk profiles.

Peters says: “A 75-year-old client of mine had a large part of her portfolio put into a fixed interest strategy hedge fund. The DFM saw fixed interest and concluded low risk. Our client lost 50%.”

Due diligence

Before investing in a DFM, first thing's first: run the necessary checks.

Martin Bamford suggests advisers begin with a review of published accounts, a check of regulatory permissions and a quick ring-around of other advisers who have been using the service.

Worldwide Financial Planning's Peter McGahan says he has a tried and tested method when it comes to DFM due diligence, although he has yet to be persuaded outsourcing to a discretionary is the right path to choose.

“DFMs sell on processes and how they go about making their decisions," he says.

"The last manager I spoke to had an outstanding process and everything about it was true. My concern is I do not know how they apply that in real terms and in real life."

As a result, McGahan always requests qualitative evidence of their success. Every month he asks to be provided with information of shares bought, sectors bought in and all the reasons for those choices.

He recommends advisers do not rush their decision but instead carry this process on for up to a year.

"If you can get that information month after month, you will get answers to all your questions and you will get a fine picture of whether what you are being told is noise, or whether it is true information.”