The route to responsible outsourcing

Fraser Donaldson, Defaqto’s insight analyst for funds, looks at the key outsourcing considerations for IFAs.

The RDR has meant most adviser businesses are reviewing their strategies in preparation for the new regime commencing on 1 January 2013. Many will conclude that delegating investment decisions to a full-time investment specialist will be in the best interest of the client. If the decision to outsource is taken there are several options open to the adviser business.

Putting your faith in multi-managers is one option. This route can allow the adviser to choose how much of his investment process he outsources. You can put complete faith in the multi-managers, selecting funds that make decisions on asset allocation, asset type and the underlying funds, or the adviser can retain the decision making on asset allocation and/or asset type by choosing an appropriate selection of multi-manager funds.

There is a growing interest in employing discretionary managers to run client investment portfolios. Here, the choice is a premium service where portfolios are constructed purely for the individual client, or (as is becoming popular with the adviser market) a managed portfolio service that retains some elements of the premium service but is an off-the-shelf portfolio designed for a segment of investors with similar attitudes to risk.

The more ambitious advisers may be considering launching their own funds run on a multi-manager basis, known as Distributor Influenced Funds. These may be managed internally by the adviser business, or the management could be outsourced.

Finally, some advisers may simply stick with the tried and tested (although not necessarily successful) route of using managed funds.

Responsible decision-making

Despite the reason for going down one of these routes is to outsource some or all of the investment responsibility, there is still a responsibility to do rigorous due diligence before making a decision.

With multi-manager, there are some 400-plus funds to choose from, although there is easily accessible data on past performance to help with the decision making, and the fund management teams are usually well known to the adviser community. The funds themselves are focused on performing well in their sector, and very few are specifically designed for a segment of clients with a similar risk attitude.

Monitoring fund progress

It is therefore very important to monitor the progress of funds selected on a regular basis, checking for things such as fund manager changes, changes in levels of risk taken, asset bias and, ultimately, performance.

A similar situation applies to the selection of managed funds, because there are hundreds of these to choose from in three different IMA sectors. Although the parameters for inclusion in the sectors are precise, they are very broad. For instance, the Cautious Managed sector stipulates there should be a maximum of 60% equity exposure, but there is no minimum. In addition, it stipulates there should be a minimum of 30% fixed interest and cash, but no maximum requirement.

Cautious, in terms of the client, will be relative, and it would therefore be dangerous to assume that just because the fund is in the Cautious sector it will apply to the client’s own notion of cautious investing. The same broad range of asset mixes also apply to both the Balanced Managed Sector and the Active Managed sector.

For those going down the discretionary route, there is perhaps more certainty that portfolios will retain a risk profile broadly suitable to the clients own risk profile. The downside is the level of due diligence that needs to be done will be unfamiliar to many advisers. There is rarely specific past performance to go on, and the investment teams will be largely unknown.

However, it is fair to say that most discretionary managers who are serious about entering the advisory market are bending over backwards to provide information required.

There are hundreds of discretionary managers in the market of all sizes. A couple of years ago there was only a handful who dealt regularly with the IFA market. This number is growing and there are probably nearly 50 who appear to be serious about this market. With a small (but growing) number of exceptions, discretionary managers are on a learning curve on how best to satisfy the needs and demands of the IFA community.

The upside is discretionary management often comes with enhanced levels of service and all investment decisions are undertaken by the manager. There is no doubt that employing a good discretionary manager would be an asset to an IFA business, freeing up a lot of time and resource. However, getting the decision right first time is very important. Switching funds where performance or style is not fit for purpose is unfortunate, but relatively easy to undertake. Switching discretionary managers is likely to be an administrative headache.

Rules and regulations

There are regulatory implications around running Distributor Influenced Funds. First, they have to get FSA approval and then come under an additional category of compliance. They are a good way of earning regular management fees, assuming sufficient support for the funds.

The problem arises if performance is not up to scratch, because it would be very difficult to justify to the regulators the continuing recommendation of the fund or funds, and we know from the RDR and associated documents the FSA will be looking closely at matters such as these. According to the rules, the ‘executive’ of adviser businesses must not exert any pressure to sell the funds through incentive or otherwise.

The overall message is there are several routes to outsourcing, but they all come with continuing responsibility. As with any products or services the first consideration must be ‘what will serve my clients best?’ The second consideration is to choose a solution that works with the business and supports the client service proposition. The solution to these two questions should not be mutually exclusive.