Is there a storm brewing in the DFM market?

29 August 2019 Jonathan Faurie
Leigh Köhler

Leigh Köhler

Regulation has introduced a lot of change into the financial services industry. With this change comes disruption, something that financial advisers are not always comfortable with or happy about.

This has forced advisers to take a step back and reassess their advice models. This is not necessarily a bad thing and has introduced a very structured approach to investing in the UK. 

Speaking at the recently held 2019 Glacier Investment Summit, Leigh Köhler, Head of Investment Solutions at Glacier Invest, pointed out that because of regulation, the rise of discretionary fund managers (DFMs) that was seen in the UK is now being replicated in South Africa. 

Shifting focus

One of the biggest changes in the UK market was the introduction of the retail distribution review (RDR). 

“In the post-RDR world, advisers are required to have a centralised investment proposition (CIP) to reduce risk and ensure consistency of client outcomes. This has led to an explosion in the use of managed solutions,” said Köhler. 

A CIP is defined as a standard approach to providing investment advice. This includes how the client's risk profile is assessed through to a centrally agreed investment solution. 

“Currently, 88% of all advised assets in the UK are held within managed solutions such as model portfolios, multi-asset funds and bespoke discretionary portfolios. That equates to R4.8 trillion in managed solutions. Of this, 49% of assets are managed on a DFM basis. This is up from 40% a few years ago,” said Köhler. 

He added that if this is broken down even further, the UK DFM industry (which consists of over 110 DFMs) manages assets worth an estimated R 2.3 trillion. The top three DFMs in the UK market account for more than 60% of assets under management (AUM). 

Local is lekker

Off the back of RDR being imposed on the UK market, the Financial Sector Conduct Authority (FSCA) introduced it into the South African market. 

As with the UK, Köhler points out that this has stimulated the growth of the South African DFM industry.

“More than 40 DFMs manage approximately R165 billion worth of assets in South Africa. The top four account for roughly 70% of the assets in this industry,” said Köhler. 

Köhler says that in the DFM space, specific metrics creates the perfect investment eco-system for positive outcomes. These are predominantly made up of scale and skill which is driven by the fact that larger companies have the skills and expertise to handle complex investments. 

Another factor contributing to a perfect investment eco-system is simplicity for the adviser as well as the client. If an DFM can communicate with advisers and clients effectively, advisers will not think twice about using them as a DFM.   

Adviser concerns

While DFMs are adding value within the investment landscape, advisers in the UK have raised some concerns regarding their dominance. 

The article points out that poaching is a major concern when it comes to DFMs. The article says that while 91% of advisers were happy to select a model portfolio service (MPS) or DFM service if the provider also has an asset management operation, some 53% were uneasy about their investment management provider also having an advice business. A quarter of advisers were concerned that a third-party investment manager would seek to poach their clients in such a setup. 

This caught the eye of the UK regulator, the Financial Conduct Authority (FCA). In a June 2017 report, the UK regulator  expressed concerns about the conflict of interest in these firms, between the different functions, and particularly cited value for money concerns. 

The article points out that advisers are taking issue with the dominance of these firms and their interpretation of the RDR arguing that their actions go against the regulation. 

The article also points out that a major reason for the introduction of the RDR was to sever the stranglehold of influence life companies and fund management houses had over the provision of financial advice. 

The article adds that one respondent to the FCA’s consultation argued that vertical integration has increased since the RDR and that in their opinion this could be interpreted as providers seeking alternative routes to regain their influence on the retail market. 

Will the poaching concerns that are present in the UK market be replicated in South Africa? The FSCA has gone to great lengths to introduce legislation that will bring parity in the South African market, and the FSCA has said in the past that it has adapted the RDR suit South African conditions. 

Editor’s Thoughts:
It will be interesting to monitor the growth of DFMs in South Africa. The quality of advice is central to RDR, and there is no doubt that DFMs can provide key insights that advisers cannot. Please comment below, interact with us on Twitter at @fanews_online or email me your thoughts


Added by Happy F., 09 Sep 2019
Is it true in SA that advisors have to do a due diligence at product level and not necessarily at fund level? Please can you quote the clause in the FAIS act if otherwise.
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Added by Happy F., 09 Sep 2019
Is it true in SA that advisors have to do a due diligence at product level and not necessarily at fund level? Please can you quote the clause in the FAIS act if otherwise.
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Added by George Dell, 05 Sep 2019
One thing that has emerged in the SA DFM market and the interactions that various industry bodies within the Financial Service Industry have had with the FSCA on the paper that is the framework for the second phase of RDR in SA namely, Discussion Document on Investment Related Matters, is that the document broadly discusses the interrelationship between, Advisors (CATI), Investment Managers (CATII), Product Suppliers and Administrators. The document points out the required differentiation of the roles between advisors, investment managers, product suppliers and administrative platforms and talks to the way they interact with each other and the “activities” they involved with in the client servicing process, with a view to ensure industry player integrity and a high level of TCF delivery to the end-client.

It’s clear from the document that each role player needs to perform a series of defined and different activities to justify a “fair and commensurate fee” which they receive for the said activities and services they give the end client in this value chain. The FSCA is clear on their intention in the document that none of the parties in the value chain should duplicate activities and earn fees on such duplicated activities. This implies that DFM’s, should not be advisors (i.e. be registered for intermediary services only), and should only focus their activities as investment managers and vice versa with advisors, i.e. advisors are not investment managers and should stick to advice related activities and not try manage money – this framework would alleviate the duplication of activities and it would also do away with fees being paid for the same activities within the same service delivery process while simultaneously doing away with any potential conflict of interest! Its suggested that advisors can have a CATII license, but the KI’s and Rep’s under the CATII should not be registered for advice or be involved in the advice activities or process, this will avoid the conflict of interest that the regulator is concerned about (which I agree with).

That said, the UK DFM model and regulatory environment allows DFM’s to act as Wealth Managers too, i.e. the UK allows DFM’s to do both investment management and advice (in my opinion a conflict of interest prevails when this takes place), but in SA the FSCA is leaning towards this being a potential conflict! I believe this is a good message for advisors and a reason for them to employ the services of a DFM (Agree with Derek, after a proper due diligence process - that should be done both ways) to help them define their CIP and offer a professional investment framework for their clients whilst staying away from all potential conflict of interest.

With this in mind, I think advisors should embrace the services of professional DFM’s and recognise that they will not be competing for the client in the advice space, the different activities will ensure that TCF is foremost when delivering a full service to the end-client.
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Added by Lindsay Bateman, 02 Sep 2019
We at Brooks Macdonald International (Category One licensed) are a DFM with some $16bn of AuM. Through our dedicated focus on building true partnerships with quality and independent financial advisors globally, the introduction of RDR into SA is not regarded as a threat. In fact our experience in the UK post RDR was very positive, as advisors focused on building, managing and retaining client relationships, delegating asset management to dedicated firms with the necessary resource, experience and expertise. Transparency of pricing is a necessary and overdue element of RDR, and only adds to client comfort when they understand who gets paid for what... Poaching would be a very unwise move by any DFM, as the long term partnership between DFM and Advisor is worth far more than any attempt to "steal" such client relationships... Advisors that embrace the new world and take on the spirit of the changes will be the ones that benefit the most, in my view...
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Added by Derek Smorenburg, 29 Aug 2019
SAIFAA is concerned about the appointment by an IFA of a DFM without a Due Diligence Process! One of the realities is that as per usual not all DFMs are created equally and that without some for of Due Diligence the ultimate responsible part, namely the IFA Practice could end up with substantial problems.
The IFA cannot rely on the the Platforms Due Diligence Processes as they are in terms of the FAIS Act totally responsible for this function.
SAIFAA will be launching a 'Member Only' DFM Due Diligence TOOL for this purpose!
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Added by Ayanda, 29 Aug 2019
As you say, RDR was indeed “imposed on the UK market” as it is being on the SA market. There is nothing “local is lekker” about, I’m afraid.
For those who have not seen through it, it is merely commission regulation in disguise and on steroids -inscrutability complex steroids at that.
Regrettably, as with all commission regulation worldwide, it is doomed to ultimate failure. It will crash and burn, consuming a long plume of unnecessary Client and advisor cash all the way down. This is to say nothing of all the wasted advisor and regulator energy it will consume.
When will they ever learn?

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