There is no doubt a DFM’s investment proposition is the “engine” of a DFM offering, but most DFMs offer other services that support financial planners in their engagement with clients and/or in the running of their businesses.
The non-investment services that DFMs offer often provide the “chassis” that allows a financial planning business to scale. While some DFMs see themselves purely as an “investment partner” to a financial planning business, increasingly DFMs are acting as “business partners”.
The range of non-investment support extends from tools used in the advice process to help financial planners and clients make appropriate investment decisions, to business support through technological and administrative services that improve operational efficiencies, as well as resources to ensure consistent and relevant communication to clients, and ultimately to offering succession solutions.
These “value-added” services go well beyond the core services of a DFM such as fund manager and asset allocation research and portfolio construction. But in the South African context, where the regulatory burden on Category I advisors is high, these non-investment services have become a significant differentiator for DFMs.
Given this increasing shift of DFMs seeing themselves not simply as investment partners but “business partners”, there are at least three key questions for DFMs and financial planners to consider when it comes to non-investment services.
A. What type of support should DFMs provide to financial planners with respect to practice management and the efficiency of their operations?
Making investment administration more efficient
There is no doubt that through “cleaning up” a financial planner’s investment book – often financial planners before using a DFM could have scores of different funds in which their clients are invested – DFMs have the potential to impact significantly the efficiency of a financial planning business’ operations.
In using a DFM, a financial planner can relinquish the task of doing research and due diligence on each fund that they use for clients, as this now falls to the DFM to do. Similarly, the financial planner is released from doing the research needed to determine the asset allocation for each portfolio that a client invests in, as well as for the ongoing tactical asset allocations that may be needed. Perhaps most importantly, given the discretion that is granted to the DFM via their Cat II licence, changes can be made to client portfolios without clients needing to be consulted.
This lifts a huge administrative burden off financial planners with a Cat I licence, who previously would have had to get clients to sign off every individual change made to their portfolio. This administrative burden is significant. Using a DFM not only makes the financial planner’s investment proposition more efficient and scalable, but also creates space for the financial planner to devote their energy, expertise and time to other activities that will enhance and add value to the client relationship.
Enabling effective and streamlined communication
Through using a select number of model portfolios, the financial planners’ communication burden to clients is eased. Without a DFM a financial planner needs to find the information and communicate to clients about all the different funds they use. In using a DFM, not only is it no longer the financial planner’s responsibility to find the information and communicate it, but the process of communicating is simplified as clients are likely to be divided into limited numbers of “buckets” depending on which model portfolio they are invested in.
This facilitates a streamlined communication process with respect to investments with DFMs usually generating the content and often branding the communication in the name of the financial planner. This “white-labelled communication” could be in the form of providing branded fact sheets, quarterly commentaries, and market updates that the advisor can send to clients under their own logo. This reinforces the advisor’s brand as the primary point of contact.
Efficiently meeting compliance obligations
Through providing fund manager research and selection services; broader investment research to inform asset allocation and portfolio construction decisions; ongoing monitoring of investments and managing of cash flows into and out of model portfolios; as well as providing the regulatory and client reporting needed, DFMs ensure that the investment compliance obligations of financial planners are fulfilled, with greater efficiency.
This compliance and regulatory de-risking assists financial planners with the heavy lifting of FAIS compliance. This includes providing auditable rebalancing trails, ensuring Regulation 28 adherence at a granular level, and drafting the investment-related sections of a practice’s Compliance Report.
Practice management support
Many DFMs offer support in the area of practice management. Key areas in which a DFM may get involved include:
- Client management: Some DFMs offer to analyse the client base of an advisor, helping them determine the profitability of their client base, and enabling them to conduct a segmentation exercise which can help streamline how they service their clients. This type of analysis invariably reveals that most financial planners have the 80:20 rule at play in their business where 20% of their clients provide 80% of their revenue. This type of analysis helps advisory businesses streamline their client service resources more effectively.
- Technology and infrastructure: While some DFMs may provide support or input to financial planners with respect to their general technology needs, there are DFMs that offer access to proprietary or licensed software for activities such as Financial Needs Analysis (FNA) and cash-flow modelling. By integrating these tools with the DFM’s model portfolios, the advisor not only reduces manual data entry errors, but ensures a greater alignment between their advice process and the DFM’s model portfolios.
- Business succession and scalability: Some DFMs offer consultancy on succession planning and practice valuations. They help solo practitioners build a “centralised investment proposition” that makes the business more attractive to potential buyers by ensuring the investment process is institutionalised rather than tied to one individual. Some DFMs also create a community or “ecosystem” within their client base that facilitates succession opportunities among the financial planners who work with the DFM.
Ultimately the support that DFMs provide beyond simply enhancing an advisor’s investment proposition enables financial planners to revise their own value proposition to clients. Having previously seen “fund picking” as an important part of their role and value add, they can now focus on the client needs more fully, and be supported by a more efficient and scalable business model. In a sense using a DFM can enable the transition from the financial planner as “technician” to “business owner”.
B. To what extent should DFMs support the financial planner in giving advice to their clients?
A key benefit of working with a DFM is that the DFM can often provide the “ammunition” and resources to enable an advisor to have deeper, more meaningful conversations with clients.
The support that a DFM can offer to facilitate this includes:
- Financial planning tools: As previously mentioned, some DFMs provide financial planners with financial planning or cash-flow tools that enable them to sync the advice that they give clients and the financial plans they develop, to the relevant DFM model portfolio.
- Investment consulting: Some DFMs offer investment consulting services to financial planners which involves analysing the existing portfolio of a client that a financial planner may wish to transfer into a model portfolio and providing the financial planner with an investment rationale that they can give to the client for the shift. Previously, this type of work would have been done by the financial planner.
- Behavioural finance tools: DFMs often provide “coaching” materials to help advisors manage client emotions during market volatility. This might include “guide-to-investing” brochures or visual aids that explain the impact of inflation and longevity risk. As previously mentioned, some DFMs provide risk-profiling and cash-flow analysis tools which enable financial planners to integrate their financial planning process seamlessly into the DFM’s model portfolio solutions.
- Technical specialist access: Direct access to the DFM’s investment committee or analysts allows the advisor to provide “institutional-grade” answers to complex questions from high-net-worth clients, effectively acting as an outsourced research department.
C. To what extent do a DFM’s non-investment services create conflicts of interest for financial planners?
The provision of “free” or subsidised non-investment services creates a complex ethical landscape. Under the FAIS General Code of Conduct, planners must act in the best interest of the client. The challenge of benefitting from non-investment services for the planner, is that these services could be deemed to be benefitting the planner first, rather than the client. There is no doubt that clients will benefit from working with a financial planner who has a more robust business model that is run efficiently. But the reality is, this is building value in the financial planner’s business, potentially influencing the rationale for the financial advisor’s choice of DFM. There is a risk that the choice of a DFM comes down to, “not what can you do for my clients, but what can you do for me?”
The consequence of this could be, for example, a DFM provides expensive practice management software or sponsors lavish “educational” events for advisors, thereby creating a sense of obligation to the DFM. The risk is that the advisor continues to use a DFM for its business perks even if the DFM’s investment solutions or performance are no longer in their clients’ best interests. Furthermore, DFMs can develop an undue influence on an advisor’s business through non-financial interests.
For example, an advisor may only be able to access the DFM’s model portfolio solutions by using financial planning software provided by the DFM. This potentially impinges on a financial advisor’s free choice to use whatever software they believe most appropriate for their client base.
While it is important that financial planners disclose the full nature of their relationship with their DFM, the reality is that disclosure does not eradicate a conflict of interest. Non-investment services provided by a DFM are a welcome boost for practice efficiency, and ideally are a significant enabler of an advisor’s ability to help their clients identify appropriate investment goals and reliably achieve them over time.
But advisors should at all times be awake to the reality that their motivation for using a DFM can be unduly influenced by the extent of the non-investment services, and this can be problematic if that supersedes the advisor’s primary duty: to act in the client’s best interest at all times.
