Rising demand for DFMs

DFMs are becoming key to a financial advisor’s value proposition to their clients.


Discretionary Fund Managers are consultants who build and augment portfolios for financial advisors so that their focus remains on giving advice to their clients. Discretionary Fund Managers examine and choose various fund managers and passive investments and then blend these to best target the returns required.

Florbela Yates, Head of Momentum Investment Consulting, says that a Discretionary Fund Manager (DFM) should become an extension of the advisor’s practice. “They become the advisor’s investment team, giving him or her access to specialist investment skills, which should improve their clients’ investment outcomes,” she says.

In 2020, The Collaborative Exchange conducted the first independent survey on the DFM market in South Africa. The aim of the study was to provide an accurate source of information to enable advisors and asset managers to assess DFMs appropriately. The survey uncovers how the larger players operate and shares data on their performance and research capability, their fees, the managers they use and their use of passive investments.

The DFMs that were surveyed manage almost R200-billion. Kevin Hinton, a Collaborative Exchange director, estimates that in total DFMs manage 10% of the R2.4-trillion invested in collective investments schemes, including unit trusts.

A DFM consultant in the UK, Abbie Knight, told the virtual Investment Forum conference that in the UK, the growth of DFMs was driven by increasing regulation.

“We have seen tremendous growth in the demand for DFMs with over 100 DFMs operating in the market,” says Yates.

Some Discretionary Fund Managers offer the full spectrum of services, which includes manager research, asset allocation, portfolio construction, administrative services on multiple platforms, production of monthly fact sheets, portfolio attribution, compliance monitoring, rebalancing and performance reporting, while other DFMs only offer some of these.

Anyone who manages an investment portfolio must have a Category II financial services provider licence, which requires more qualifications and experience than the Category I licence that most financial advisors hold. Category I licence advisors may contract with DFMs to manage a client’s investments completely. Those advisors with Category II licences run their own funds, using DFMs as consultants.

We have seen tremendous growth in the demand for DFMs with over 100 DFMs operating in the market

Yates explains that there is a difference between those that use their Category II licences mainly to create efficiencies for their own network of advisors and those that offer services to third-party advice businesses. “Category I advisors often partner with a DFM to help them with portfolio construction, manager or fund selection and the efficiencies that a Category II licence brings,” says Yates. “For example, a DFM can apply asset allocation or fund changes simultaneously across all advisors through the ability to bulk switch, whereas a Category I advisor would need to meet with each client and get their signed consent to make these changes.”

Although advisors with a Category II licence can legally provide these services, many are smaller firms without the necessary skills to provide the full range of services. In these instances, they often appoint a Discretionary Fund Manager in a sub-advisory role.

During the pandemic, advisors who had a DFM benefitted by having the ability to implement any decisions made across portfolios. A Category II licence allows the holder the discretion to make changes to both the underlying asset classes and funds, which means all clients benefit from this advantage at the same time.

Advisors also partner with an independent DFM to simplify their offering and cater for the increasing compliance burden. DFMs could also assist advisors looking at buying or selling books, or to develop a succession plan.

The Collaborative Exchange survey divulges that advisors should check the ownership structure, experience and qualifications as well as the culture and size of the manager research team of
any DFM they plan on using.

DFMs have different research processes and use various tools, including some of their own, to analyse portfolios and managers.

The survey also reveals that DFMs favor active managers and use differing degrees of passive managers, ranging from 7% to 35% of their portfolios. Some use funds in their own group and some use more boutiques than others.

“I am encouraged by the suggested licensing requirements for different categories of licences that we saw under the latest RDR proposals,” says Yates but shares that she would like to see the industry becoming more professional and transparent in terms of both fees and skills.

Yates believes that consolidation and digitisation are two big trends in this market that will continue for the foreseeable future. “Compression on fees is another trend that I’m seeing especially in a low-return environment. I also believe that RDR will have a significant effect on advisors and asset managers.”