A Discretionary Fund Manager (DFM) provides professional and expert investment services to financial advisors, relieving them of the job of researching, choosing and blending different managers into investment portfolios for their clients. A Discretionary Fund Manager has the necessary licence and mandate to buy and sell investments on behalf of clients.
Regulation of financial advice processes, including the Financial Advisory and Intermediary Services (FAIS) Act in South Africa, has fuelled the growth of DFMs that meet financial advisors’ requirements for well-researched and managed portfolios that are matched to client needs.
South African DFMs
The first South African DFM, Analytics was spun out of Investec in 2004 as the FAIS Act became effective. Since then the number of DFMs operating in South Africa has increased to around 60, according to Pat Magadla, head of distribution at Equilibrium, the DFM in the Momentum group.
The latest NMG Consulting survey of South African Advice Models notes that R315-billion of assets advised on by independent financial advisors, excluding that of advisors in networks, are managed in conjunction with a DFM. Including advisor networks, the investments managed by DFMs are estimated to be between R450-billion and R600-billion, according to the Collaborative Exchange’s 2023 DFM survey. The NMG Consulting survey shows that 57% of South African financial advisors are using DFMs’ investment services and 73% of them are expected to increase their DFM usage in future.
DFMs are effectively multi-managers
While all DFMs are effectively multi-managers, not all multi-managers have DFM business models that are geared toward providing business solutions for financial advisors. Single managers, multi-managers and DFMs are all investment managers who offer unit trusts funds, and their funds can be directly compared on performance, cost and consistency. But what differentiates a DFM is that their products are crafted into holistic solutions for advisors and their clients.
Good DFMs will ensure advisor partners have a comprehensive set of investments that are integrated into their advice process and aligns with their value proposition. A credible investment partner frees advisors from distractions and allows them to focus on the client conversations.
How they are regulated
South African DFMs must be registered as a financial services provider (FSP) with what is known as a Category II financial services provider licence under FAIS that allows them to manage investors’ money on a discretionary basis. DFMs must abide by the Code of Conduct for Administrative and Discretionary FSPs published under FAIS by the Financial Sector Conduct Authority (FSCA). This code binds DFMs to obtain a written or electronic mandate with their clients after obtaining information about their circumstances, needs, objectives and other information required to provide a suitable service. It also obliges DFMs to provide written reports that include the market value of the investments and show the charges at least once every three months and on request. The FSCA’s 2019 Retail Distribution Review document made some proposals about formal agreements, conflicts of interest and disclosure of portfolio and fees. Further regulation is expected when the Conduct of Financial Institutions Bill is enacted.
Qualifications and experience
- A DFM should have a diverse and experienced team to provide a wider perspective on investment decisions.
- A DFM team may include qualified actuaries, accountants and holders of the Chartered Financial Analyst, Chartered Alternative Investment Analyst and Certified Financial Planner qualifications.
Services offered
The investment products and services that DFMs offer are standard model portfolios (reflecting their best investment view), or highly customised (bespoke) solutions suited to specific clients.
- Financial advisors with either Category I or Category II financial services provider (FSP) licences make use of DFM services.
- Some Category II advisors primarily engage DFMs for asset consulting, while using their own Category II licence to implement portfolios.
- Other advisors rely on DFMs not only for asset consulting but also to implement portfolios on their behalf, either as model portfolios or as unit trust funds on investment platforms.
In order to facilitate bulk switches when portfolio changes are necessary, DFMs, in conjunction with an advisor partner, must obtain signed investment mandates from clients. These documents must comply with the FSCA’s requirements.
DFM’s managed investment solutions or consulting services are likely to come with:
1. Determination of appropriate risk and strategy
Jonel Matthee Ferreira, CEO of Cogence, the discretionary investment manager in the Discovery Group, believes that the investment process should start by defining the investment objectives of each solution identified as suitable for clients before the appropriate investment risk and strategy is determined.
2. Asset allocation
George Dell, executive director at DFM MitonOptimal, is of the view that a DFM does its job effectively and efficiently when it does asset allocation. In order to create an investment thesis, a DFM must understand the payoff profile of asset classes in the past, and have a reasonable forecast for those assets classes’ future returns, he continues. If a DFM is just choosing the best performing funds without doing asset allocation or trying to understand the behaviour of asset classes, they will do clients a huge injustice, he says.
DFMs consider forecasts for global asset class returns, risk and uncertainty and combine these with insights into the optimal allocation to determine a strategic or long-term allocation that drives most of the risk and return, Matthee Ferreira explains. DFMs also use dynamic or tactical allocation to adapt the long-term strategic asset allocation to take advantage of the current market environment, potentially adding additional alpha, she says.
3. Manager selection
Researching, screening and selecting fund managers is a key service that DFMs offer. There are now more than 1 800 local collective investment schemes and many thousands more globally, making the selection process complex. A DFM has the investment skills required for
this and can do so with efficiency since it will serve several advisory practices.
4. Portfolio and risk management
Once managers have been selected, DFMs typically review the overall portfolio, often using their technology platforms to determine the investment risks and how these can be managed. Potential future risks should be stress-tested under different market scenarios and asset classes are researched to determine optimal diversification benefits and reduce volatility, Matthee Ferreira says. Continuous monitoring and rebalancing help to ensure that portfolios work well through time.
5. Standard and customised portfolios
It is generally accepted that DFMs reduce complexities and minimise investment compliance risk in advisors’ practices, which is achieved by consolidating and centralising clients’ portfolios into the appropriate and consistent strategies for advisors. However, aligning every client’s portfolio to these strategies can be challenging as many clients use different investment platforms or hold existing investments they prefer to retain or transition out of gradually. Funds required for a tailored portfolio may not be available on platforms with limited choice, but DFMs can identify suitable alternatives to meet the asset allocation strategy.
In some cases, advisors’ clients are not willing to move to the preferred platform. DFMs also have a solution for this: a suite of core portfolios can be offered on each platform so advisors can use these as an alternative when they do not have sufficient assets to justify their own tailored model portfolio on the platform a client has chosen.
6. Communication and Compliance
Once a centralised investment proposition is established, advisors can effectively communicate with investors and DFMs assist with this by creating fact sheets for each investment portfolio. These may be branded for an advertiser to share with clients. In addition, DFMs usually host investment committee meetings with advisory practices. These meetings ensure advisors have a thorough understanding of the portfolios, including components such as alternative investments like hedge funds, the performance of individual investments and the rationale for any adjustments being made. This collaboration empowers advisors to keep clients informed and confidently address their questions, Dell explains.
A DFM’s support for an advisor should extend to standing behind its portfolios. If an advisor partner is challenged by a client or faces a complaint lodged with an ombudsman, the DFM can step in to represent the advisor, explaining and justifying the investment decisions.
-George Dell, executive director at DFM MitonOptimal
Matthee Ferreira says a valuable role DFMs can play for advisors is to provide them with information to explain to clients the impact of potential market events on their goals and help them make informed investment decisions. In addition, DFMs can help advisors show clients the impact of savings habits, health and the impact of longevity on financial needs in retirement, she says.
7. Add-on services
Many DFMs offer add-on services such as signing up or on-boarding clients, and additional propositions include planning tools, assistance with practice management, access to portfolio managers and thought leadership.
Types of DFMs
There are probably three distinct types of DFMs:
- The independent retail DFM: Independent, owner-managed DFMs with no corporate ties that serve independent financial advisors.
- The in-house DFM: DFMs run as separate businesses within larger wealth advisory businesses.
- The corporate DFM: DFMs within large life insurers or financial services groups. They mainly serve tied financial advisors but can be used by independent financial advisors.
Recently a number of corporates, including Discovery, Momentum and Alexforbes, have built DFMs out of their multi-manager businesses. There are also advisory businesses that have their own Category II licence and give advice and manage investments on behalf of clients. These businesses continually have to balance the costs and benefits of doing their own investments versus using a DFM. Some of these businesses do use a DFM as a consultant to help them manage their investments, but they – rather than the DFM – take full responsibility for the investment outcomes.
Matthee Ferreira reveals that Discovery launched a corporate DFM because the group recognised that a DFM can help advisors grow their practices and manage advice risk by streamlining their investment propositions. A centralised, repeatable investment approach leads to better outcomes by reducing poor investor behaviour, boosting satisfaction and improving client retention.
Brandon Zietsman, global CEO of PortfolioMetrix, also has an explanation for why corporates are launching DFMs:
large financial institutions have a plethora of products and distribution channels. They offer single manager investments, multi-manager investments, alternative investments, property investments and more through private bankers, financial advisors and tied agents.
-Brandon Zietsman, global CEO of PortfolioMetrix
Tied advisors in these institutions can choose whatever fund they like on the group’s investment platform. To ensure these advisors can compete with independent financial advisors, their choices are not restricted but this also results in a lack
of control over the funds used, the asset allocation and local and offshore split, Zietsman says. The result is a lack of consistency and a lot of regulatory risk, he says. Zietsman says launching a DFM resolves these problems for financial institutions.
While independent advisors can use corporate DFMs, they typically prefer DFMs that are independent of any group and have long track records, he adds.
