Fund managers predict IFA consolidation and the rise of the DFM

South Africa’s fund management landscape has undergone a remarkable transformation over the years, shaped by regulation, market dynamics, and the evolving needs of investors. One can follow its path from the wild-wild west of pre-1980s brokering, to the rise of indexation and unit trusts, to the advent of multi managers, to an era during which most asset managers and financial advisers were building portfolios on what you might call a core-satellite approach, to the multi-asset or balanced fund years, and finally, to the rise of discretionary fund managers (DFMs).

Outsourcing asset allocation decisions

In a fund management focused panel debate during the recent Glacier Investment Summit, Rafiq Taylor, Head of Implemented Consulting at Glacier Invest, singled out regulation as a key driver for change among financial advisers and providers to the financial advice industry. The panel moderator said that the country’s fund management evolution, as described in the opening paragraph, was helped along by financial advisers’ desires to outsource those all-important asset allocation decisions. Into the future, asset managers will have to build solutions for problem statements linked to the end client, with data and technology informing much of the process. 

The first question put to panellists was whether they agreed with the broad evolution just described, and what role they saw for financial advisers and DFMs going forward. Siobhan Simpson, Head of SA Unit Trusts at NinteyOne, singled out the complexity of financial markets; volatility; the fear of regulation; and DFMs positioning their value propositions as reasons for a shift from multi-asset solutions to building blocks of specialist funds under DFMs. “We think that about 20% of the independent space has got a DFM relationship in place, rising to 50% if you include large corporates,” she said. The penetration will increase as DFMs sign up more clients and consolidation in the IFA segment gains momentum. 

Backing specialist funds to add value

“DFMs are increasingly looking to specialist funds to add value,” said Hildegard Wilson, Head of Investment Solutions at Glacier Invest. She said the transition from advisers doing asset allocation to the decisions being given to asset managers and DFMs was an opportunity for asset managers to expand their offerings. “Asset allocation is very difficult; even though it is an area where DFMs add value, there are still pockets of value in the asset manager industry,” she said. 

JP Matthews, Head of Product at Matrix Fund Managers, identified the rise of the DFM as a driving force in the evolution of financial advising and fund management. “We see two types of DFMs out there; those that want to do all the asset allocation themselves, and those that prefer fund managers to do some of the asset allocation,” he said. He commended DFMs who were still using multi-asset funds in their solutions, with the typical approach being to use multi-asset solutions alongside specialist portfolios in a type of core-satellite or hybrid portfolio. Flexibility is key, and investors must be able to decide whether they want a multi-asset mandate, or some form of carve-out that favours bonds, equities, or fixed income. 

Taylor opined that financial advisers were backing DFMs for their expertise in building investment solutions, freeing up advisers to focus on the advising side of the value chain. Simpson was more forthright in her response, saying that, “There is no hiding place for asset managers who do not add value through their asset allocation.” She conceded that some DFMs stood out for their excellent equity carve out capabilities, making them a great addition to a client’s portfolio. From Matthews’ perspective, asset managers have to appreciate the emotion and value chain behind fund flows in the broader asset management environment. 

Regulation not the only challenge

Regulation presents challenges to all stakeholders in the asset management and financial advising disciplines; but it is not the only challenge. “The opportunity set where you can add value is not as broad as it used to be,” Wilson said, with specific reference to the de-listing trend on the JSE. She also commented that recent regulatory interventions were driving a wedge between hedge funds and unit trusts. “The regulators are talking about excluding hedge funds from new CIS tax amendments; and that will push back the inclusion of hedge funds into the CIS space,” she said. It is being left to Cat II advisers or DFMs to expose retail clients to hedge funds. 

“The big issue is that when you are running a balanced unit trust that is regulation 28 compliant, the regulation does not allow you to invest into retail hedge funds, whereas someone running a portfolio for a retirement fund can,” Matthews agreed. He pointed out that the retail flow into hedge funds was predominantly through living annuities and so-called model portfolios. On the tax matter, Matthews said it was difficult for the Financial Sector Conduct Authority (FSCA) to update regulations without clear guidance from National Treasury and the South African Revenue Services (SARS) re the taxation approach for both CIS and Retail Investor Funds (RIFs). 

Taylor steered the conversation to the suitability of the Association for Savings and Investment South Africa (ASISA) fund categorisations, asking whether they were helpful to financial advisers in their day-to-day client interactions. Simpson commented on the wide return dispersion in categories, suggesting that the categorisation was too wide. “If you look at the return dispersion over three years within the high equity category, the worst performing fund is at 12.7% (cumulatively) versus the best performing fund at 57%,” she said. The risks attaching to these funds are clearly not the same. 

Income fund dispersion far too wide

In the multi-asset income category, the best-returning fund was up 18.3% versus the worst at just 6.7%. The dispersion is too wide given investors should expect similar risk profiles across the category. Wilson said she respected the ASISA classifications; but felt they were not useful in adviser-client conversations. “Your clients do not know what or who ASISA is, and I doubt the association [intended its categorisations be used to help advisers explain to clients] the risk profile of individual CIS funds, or what needs they meet,” she said. Financial advising begins with understanding what your clients need and then building a portfolio that meets that need. 

The conversation closed with a final comment on active versus passive fund management. “Over the past 20-years the percentage of global assets in active management have dwindled from around 50% to 25%; passive funds have grown from around 10% to 25%; and alternatives have grown from 5% to 12%,” said Taylor, setting the scene. “We have to be careful to simply extrapolate what we see in the US, for example, with what is going to happen in South Africa,” Simpson said. One reason for the US skew to passives is that investors in that market get a tax benefit to invest into passively managed index or exchange traded funds (ETFs). 

DFMs could slant the playing field to passives

Fair enough; but will the proportion of passively managed assets continue to rise in South Africa? “If you look at our overall assets under management (AUM) the percentage of passives among non-DFM clients sits at 4-5% whereas among our DFM clients it is closer to 20%,” Simpson concluded. “You are definitely seeing an increase in passives as more IFAs sign up with DFM.” For IFAs, the challenge remains to lock in beta by using the right active managers, and to pay careful attention to the market concentration risk inherent in many passive indices. 

Writer’s thoughts:

The rise of discretionary fund managers (DFMs) is shifting the asset allocation decision away from financial advisers, perhaps chipping away at the Cat II IFA market. Are you comfortable with outsourcing investment decision making in favour of spending more time with your clients? Please comment below, interact with us on X at @fanews_online or email us your thoughts editor@fanews.co.za.