How important is governance and oversight on Discretionary Fund Management (DFM) and Managed Portfolio Service (MPS)?

The increasingly complex investment space means asset managers and financial advisors are relying more heavily on outsourced investment management services, more commonly known as Discretionary Fund Management (DFM) and Managed Portfolio Services (MPS). Although the market is becoming crowded, there are no signs of slowing down, and assets under management by these outsourced services are expanding year on year.

Indeed, outsourcing investment management to third parties is seen as one of the fastest-growing market segments in this space. For example, assets in MPS platforms grew by 25% during 2020, faster growth than both private client business and adviser bespoke portfolios, and the strong upward trend has continued through 2021.

In this article, we will outline and further uncover the rise of Discretionary Fund Management (DFM) and Managed Portfolio Services (MPS) industry and how it is impacting due diligence.

What are Discretionary Fund Management (DFM) and Managed Portfolio Services (MPS)?

Discretionary fund management implies the client´s maximum trust in the investment manager´s capabilities and operating principles. As the term “discretionary” suggests, investment decisions are made entirely at the portfolio manager’s discretion. It is up to DFM to understand how much a client wants to invest, their risk appetite, and financial goals, and then, based upon the asset managers and financial advisor’s circumstances and objectives, build a highly tailored investment portfolio.

Apart from this system, applied to high-net-worth individuals (HNWI) and institutional investors, such as pension funds, there is another spin on the highly tailored nature of discretionary management services providers. Managed portfolio services (MPS) have gained popularity in recent years and can provide better opportunities to smaller investors by fitting them into a particular portfolio based on their profile and investing preferences. In other words, asset managers and financial advisors can join other parties with the same preferred management style and risk appetite, in an investment pool.

What services is discretionary fund management providing, and how are they helping advisors?

DFM offers bespoke solutions that are tailored to each of the clients’ specific needs and aspirations. DFM is usually considered when a client has highly complex requirements and takes on more risk to generate higher returns, although there are no guarantees.

Once the portfolio has been built, the DFM will make ongoing decisions about the portfolio and normally offer greater visibility of what the underlying investments are. For example, a DFM will disclose the performance of the traditional investment instruments in the portfolios such as stocks, bonds, etc. However, with a fund or ETF portfolio, a client will get less information about the underlying investments instruments.

Each MPS approach offers an amount of risk levels, so there should be a suitable option for most clients – from the most conservative to those willing to accept higher risk for potentially more reward. MPS can leverage its scale and apply highly rigorous research methods that allow them to scour the globe for the most compelling opportunities to include in the different portfolio offerings.

Pros of Discretionary Fund Management/Managed Portfolio Services:

• DFM/MPS have a great deal of investment experience and expertise at their disposal.
• Outsourcing to DFM or MPS, where the third-party investment specialist makes investment decisions, is a favourable option for advisers lacking the resources to manage client assets physically.
• Outsourcing the running of clients´ money can be advantageous to some advisers, partly because it can reduce risk in their business and partly because it allows them to concentrate more on financial planning.
• Clients with ethical requirements or those wishing to exclude specific investments can leverage the work done by these firms and use DFM ‘bespoke’ route or MPS portfolio.

Cons of Discretionary Fund Management/Managed Portfolio Services:

• Costs are often listed as the biggest disadvantage of DFMs/MPS. The problem is not only that they are higher than for some other centralized services, but costs and the value for asset managers and financial advisors are not always the most transparent.
• Outsourcing means advisers no longer have direct control over pricing, and if they are unhappy with the performance, moving a DFM/MPS portfolio can be cumbersome. Trust is another key drawback cited by advisers – they fear losing control of the relationship with a client due to an investment manager taking over a share of responsibility for the client’s interest.
• There may be no integration with an adviser’s back-office system unless the portfolios are managed on a third-party platform, adding another charge layer. The adviser will be giving away a potential source of additional profit, which may not be recouped in additional adviser fees.

Why is due diligence essential?

Like strategies and mandates, investors are facing a number of growing options, such as active, passive, and more recently, ESG investing. Given the ever-changing nature of the DFM, MPS, and the investment landscape, a strong handle on governance and oversight could prove vital in eliminating unnecessary risk to a client.

When undertaking due diligence on a DFM or MPS, clients should treat them as a strategy or fund within their portfolio. This means performing proper and rigorous due diligence and assessing them for key areas of particular interest to the client.

Due diligence on discretionary fund managers or managed portfolio services

Key steps when conducting initial due diligence on DFM and MPS providers:

• Issuing a questionnaire to the DFM/MPS, including detailed questions about their process, fees, history, etc.
• Evaluating and analyzing the responses based on a set of rules or flags.
• Generating reviews and evaluating the DFM/MPS on a set of criteria, such as:
  • People
  • Process
  • Performance
  • Philosophy

Key actions to implement when monitoring DFM and MPS providers:

• Consolidating the information collected in a single and easily updated data source.
• Issuing a quarterly questionnaire to gain more transparency.
• Comparing responses for the same or different DFM/MPS on a yearly or quarterly basis.

How Dasseti can help

Performing due diligence on a DFM and MPS requires similar analysis to any other fund due diligence process. This extra layer of investigation will reap rewards in the long term.

Dasseti enables investors and financial advisers to collect individual data, not only on fund managers but also any third party, including DMS and MPS providers. We help investors efficiently review and analyse DFM/MPS firms with our advanced due diligence software solution. The efficiency gains allow investors to effectively review more DMS and MPS providers, at a deeper level. A dedicated due diligence platform like Dasseti offers a seamless approach that is tailored to your needs and adapts over time to support your business as it changes and grows.

For more information, please contact us.