Should financial advisors use a DFM?

An exclusive Blue Chip discussion with three of the country’s top investment and financial planning professionals focused on Discretionary Fund Managers and how advisors can best utilise their services.

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Expert panel

Moderator

Ian Jones is the Chief Executive Officer and Director of Fundhouse South Africa, based in Cape Town. Ian joined the Fundhouse business in 2013. He is a qualified actuary who started in the investment industry in 2001. He has extensive experience in fund research, portfolio construction and the broader asset management and financial advisory industries.

Ian was previously the Chief Operating Officer of a boutique asset manager in South Africa. He also has international experience, having spent five years in Australia and 2 years in the United Kingdom.

Barry O’Mahony, Certified Financial Planner Professional, Veritas Wealth Management

Barry O’Mahony founded Veritas Wealth Management, an independent financial planning practice, in 2004. Barry holds the Certified Financial Planner CFP® Professional accreditation.

Ebrahim S Moola, Senior Financial Advisor,
Bobats Wealth Solutions

Ebrahim is the founder of Sterling Invest (a boutique, CAT II discretionary investment manager) where he fulfils a senior portfolio manager role.


IAN JONES (IJ): What do you see a DFM as in our industry?

EBRAHIM MOOLA (EM):

For us, partnering with a DFM felt like we could focus on what we were getting paid to do as a Cat I financial planning (FP) business, and that’s putting together proper financial plans; really understanding and helping our clients achieve their financial planning goals. DFM solutions or the services they offer are quite specialised within the investment management field of the broader financial planning landscape.

We very quickly realised that the complexities involved within the FP process necessitated us to work with an investments partner to do the specialised work required for putting investment solutions together. And we didn’t necessarily want to have to make additional investment decisions, given that in the 21st-century, investment management has become quite sophisticated. We felt we’d rather partner with an outsourced DFM to help us with this investment solutions aspect of what we need to put together for our clients.

IJ: Ebrahim, when you first decided to partner with a DFM, was there an aha moment when you realised it was the right thing to do?

EM:

The aha moment probably came when going through the painstaking initial process with our outsourced DFM partner in putting together the various models for our clients. There’s so much nuance and specifics that came up. The DFM raised issues in coming up with these mandates that we hadn’t even considered. From that point on, I can say with confidence that the decision-making (by the outsourced DFM partner) that went into selecting the fund managers, into the asset class allocation, into the various investment styles incorporated into these baskets of funds, that a lot of work had been done behind the scenes. I can hand-on-heart say that we’re putting the client in the best possible position from an investment perspective by working with an outsourced DFM partner.

We can add value as financial planners on the fluffy stuff of relationships and partner with investment specialists (outsourced DFM partners) whose life’s work is building model portfolios in the context of our client base and business.

We’re fortunate to have our own Cat II business so we are still the final trigger-puller on what gets into the models and any changes that are made. But 99.9% of the decisions that are used within the model portfolios are the DFM’s decisions and we know the work has been done behind the scenes by experts in fund manager selection, asset class allocation and review of macro-economic data to understand which style of investment is best suited for the medium to longer term.

We have that comfort that we’ve partnered with experts and in this complex environment that we find ourselves in where there are countless investment options available for clients, our outsourced DFM helps us demystify and simplify them into one of our 12 model portfolios. An overwhelming majority of client objectives can be catered for within these model portfolios that we’ve created.

J: Fees are a prickly issue when returns are low and fees across the value chain have come under pressure. How does a DFM fit into the value chain with the amount of pressure on fees now?

EM:

Historically, the DFM’s layout fees weren’t there and now there’s a new entity that’s taking a sliver of the fee that the client pays. For the discerning or fee-sensitive client, the appropriateness of the fee is questioned, but it has never been a case of, “I don’t want to use the DFM because I am not willing to pay 20 or 30 basis points for the services they offer”.

EM:

In my opinion, the FA fee should be the highest as a percentage of total followed by the DFM and thirdly the asset manager with the platform fee last. So just in this value chain, I feel the DFM fees are reasonable relative to their value.

Barry O’Mahony (BOM): And the value, the reason that the FP fee is higher, is because an FA is limited in the amount of clients that they can deal with. A DFM allows us to receive rather than investigate information. Because they are ahead of the game, we receive that information much earlier. DFMs allow us to spend more quality time with our clients in the FP area and that is where the value is added.

EM:

The value proposition that you advertise to your client base is probably the biggest factor in deciding whether or not to work with a DFM. If you purport to be an investment specialist and want to be involved in the investment decision on behalf of your clients, an outsourced DFM may not be a good idea.

But then I look at what we’ve done. We set out within the industry wanting to be inherently involved in the investment decision. Within the model portfolio space, there’s a certain skillset of choosing fund managers, asset class allocation and reporting on model portfolios. We weren’t comfortable making a group of decisions on behalf of our clients.

We focused our investment management capabilities on stock-picking, where our Cat II business develops its process. On the model portfolio side, which is a very different skillset to individual stock-picking, we felt that a third-party outsourced DFM was the better solution.

It comes back to that value proposition you’re purporting to your clients and how you want to add value. An FP business is not that scalable, only a specific number of clients can be serviced within a limited amount of time each day.

The best FP practices truly understand and engage with clients in meaningful ways that add value to their long-term goals, help them achieve their ambitions and invest in the right products. We believe in working with partners who do it better than us and act in the clients’ best interests.

BOM:

A DFM it is not the panacea for all investment problems.

EM:

I don’t necessarily want to say it’s the flavour of the month but right now, based on all the tools and options available to the independent FA, it does feel like the DFM solution makes the most sense for our practice. It could be that a multi-manager solution or choosing your own funds works best for you but right now, for us, the DFM solution makes the most sense.

IJ:Does a DFM impinge on the FA’s independence?

BOM:

I don’t think independence is a big issue. Most DFMs are smart enough to know that if they start overusing their own funds, they’ll blow themselves out of the water.

It’s still the advisor that must continually reassess if they made the right decision. Should I use a multi-manager/share portfolio/property trust/passive balance funds/this DFM? Does it all add up or am I falling behind here? And if you are falling behind then stand up and address it.

EM:

As long as we remain independent internally or as an FP business, that we’ve done our checks and balances to confirm the outsourced DFM we’ve selected is independent and if I have the option to dismiss the DFM at any point, independence is not an issue.

IJ: Any advice for those considering a DFM?

EM:

Ideally, it needs to make sense for you as a practice to partner with a DFM. Once you’re at a certain scale or looking to grow and you need more time to meet with more clients, it may be time to consider an outsourced DFM.

If I consider the impact it has had on our practice, I feel totally justified working with an outsourced DFM. In 2023, it’s the right thing to do based on the complexity of our work.

BOM:

The overarching focus in your job is giving advice. DFMs free up time and build a better process that is a deeply researched and properly implemented part of your business. For example, as a Cat I if we decide to switch out of a fund that all our clients have, who do we start with? The biggest clients, the smallest ones?

If we do nothing else except switch our clients out, it will probably take two months to solidly review our client base. That’s ridiculous, it’s not a value add. It could take two years by the time we get all our clients out of that fund, whereas DFMs bulk-switch.