Beyond portfolio construction, DFMs increasingly differentiate themselves through non-investment services that shape practice efficiency, scalability and client engagement. The DFM in South Africa has evolved from a simple service provider into a potential “ecosystem owner”.
Both institutional and independent DFMs are creating commu-nities of advisors around them in which they are facilitating relationships between their DFM clients as well as deepening relationships with themselves by creating operational dependencies on the DFM through both investment and non-investment services.
What started out as a bilateral relationship between DFM and advisor has evolved into multilateral relationships which leads to a delicate balance where the question could be asked, does the DFM empower the independent advisor, or does it slowly absorb them? We consider this question by looking at the impact of these growing DFM communities, a shift to vertical integration and the question of whether size matters in the DFM space.
A. What is the impact of DFM “networks” of advisory businesses which evolve as DFMs grow their client bases and begin to create communities around their offering?
We are seeing the rise of “DFM-led communities” in the case of institutional DFMs (eg Graviton, Equilibrium and Symmetry) and independent DFMs (eg Fundhouse, MitonOptimal and PortfolioMetrix). These DFMs are not just playing the role of investment engines – they are developing professional networks.
The “community” upside
In some cases the DFMs offer the institutional power of a large corporate (eg shared costs or subsidised costs for services and/or tools; centralised operational and management support) but the IFA retains their independent FSP licence. This allows small independent practices to compete with bigger players on a more level playing field. Perhaps the two biggest benefits of a “DFM-led community” are the following:
- Peer sharing and benchmarking where the communities allow advisors to share insights and experiences as well as compare their practice metrics (fees, client retention, AUM growth) against their peers. This is a powerful driver for professionalisation and implementation of sustainable business practices.
- The consistency that DFM investment solutions offer different independent financial planning businesses combined with the non-investment services provided to the businesses within a “community”, provide a sound platform for DFMs to facilitate succession conversations and implement succession solutions between members of their DFM community.
There are risks to becoming a member of a DFM-led community:
- The potential for “groupthink” – where members begin to adopt an “homogenised” advice model and investment proposition propagated by the DFM, and as a result use the same “house view” and the same client collateral, thereby potentially diluting their unique value proposition and their positioning of independence.
- The risk of dependency – where independent advisors become dependent on the DFM providing services that influence the growth of their businesses, like investment consulting services to persuade potential clients to move their existing investment to a DFM, or begin to rely on the brand of the DFM for credibility.
This dependency could then make independent advisors vulnerable to being integrated into the DFM’s business as DFMs try to capture more of the value chain to protect their own business.
B. What is the risk of DFMs vertically integrating their clients and becoming full-service FSPs with Cat I and Cat II capability?
Full vertical integration occurs when a single entity owns the platform (LISP), some or all of the funds used in the model portfolios, the DFM (Cat II) and the Advice Arm (Cat I). Partial vertical integration could take place where the DFM owns the advice business.
There are already DFMs that are taking partial or full stakes in advice businesses. This begs the question whether there is a risk that a DFM could shift from being a partner to a competitor. Full vertical integration happens most commonly via institutional DFMs, particularly those backed by large financial intitutions.
By offering independent advisors a succession solution, these institutional DFMs move from “supporting” the advisor to “owning” the client relationship. This creates an additional risk that independent advice is undermined as the institution makes use of direct digital channels or a tied-advisor model to extract more value from the relationship.
True DFM support for independence requires an “open architecture” approach where the DFM is free to fire the parent company’s funds if they underperform. In a vertically integrated model this becomes very difficult. Vertical integration enables the institutional DFM to extract fees at each point in the value chain. This could be beneficial for a client if it allows for “fee bundling” where some costs may be reduced.
Conversely, if an advisor is owned by a DFM, they will be less able to influence how model portfolios are constructed with the risk that more expensive funds owned by the institution are included in portfolio solutions to the detriment of the client. Similarly advice fees may be prescribed by the institution rather than being at the discretion of the advisor.
C. To what extent does size matter in the success of a DFM business?
Size definitely matters when it comes to DFMs, but it is not necessarily clear whether bigger or smaller is better. There are merits to both. The bigger the DFM, the more likely it is that the DFM will be around for the long term and there is a greater likelihood that with larger assets under management, the DFM will be able to negotiate lower fees with underlying fund managers. It is also likely that the bigger the DFM, the more capital they will have to invest in technology, AI-driven tools and robust cybersecurity.
They are also likely to be able to offer a comprehensive range of non-investment services to financial planners. While the scale benefits of a large DFM will be significant across the board, the reality is that size gives the DFM more leverage in their relationships with clients. Or put another way, the influence of an individual financial planner on a large DFM is likely to be limited.
Requests for changes to a portfolio, the introduction of new fund managers, or requests for changes in activities like reporting and communication are unlikely to get much air time.
The key benefit of working with a smaller DFM is that a financial planner is more important in that DFM’s world. Hence requests are likely to be given more of a hearing. There is likely to be greater potential for more customised portfolios; more openness to tactical portfolio shifts; and greater flexibility in support and non-investment services.
A potential drawback of a smaller DFM is that they are likely to have less leverage over underlying fund managers and this could be reflected in the pricing they are able to negotiate for the fund in their clients’ model portfolios. So size definitely does matter, but it depends what is important to you as a financial planner.
Are you looking for a strategic business partner (smaller DFM) who will be very attentive and responsive to your particular needs – both investment and business related; or are you happy to work with a larger DFM who may operate more like a very efficient service provider, rather than a dedicated business partner?
