How outsourcing stacks up for advisers

Regulatory changes such as the Retail Distribution Review and Centralised Investment Proposition rules, along with downward pressure on costs and charging, have combined to create a dilemma for advisers.

Should advisers be recommending, managing and monitoring their clients' investment portfolios in-house, or outsourcing to specialist discretionary fund managers?

For some advisers, outsourcing to a discretionary (DFM) makes sense, allowing them to focus on the adviser-client relationship while the DFM manages the portfolio.

For others, keeping their clients in-house reduces the risk of cross-selling or the risk that a DFM portfolio may start to drift away from the original investment parameters.

Ultimately, deciding whether or not to outsource should be a decision for the financial planner and their clients.

Lack of clarity on outsourcing carries risks for advisers and clients

Failure to clarify lines of responsibility when outsourcing can pose risks to advisers and their clients, a director at the Tenet Group has warned.

Helen Ball, group distribution and development director for the Tenet Group, said: "It must be clear which responsibilities are held by the adviser and which by the discretionary fund manager (DFM), and that this is well documented in the tripartite agreement.

"Failure to have clarity can lead to the customer not getting the service they are paying for as both the adviser and DFM may assume that certain tasks will be done by the other."

Although there is a marked trend towards outsourcing clients to DFMs, Ms Ball said another concern was cost.

She explained: "As with anything, it can be assumed extra services like the ability to bespoke or manage CGT, are better to have than not.

The adviser needs to be very aware of what additional benefits it has, if any, that are appropriate for their client for the extra cost

Helen Ball, Tenet

"However, everything has a price and it’s important not to place the client in a more expensive DFM solution when a multi asset fund would have met their needs.

"Also, discretionary fund management is a service, therefore VAT is payable on everything and it is important this is taken into account when looking at costs."

She said there had been a rise in the number of DFMs which have unitised some of their model portfolios to avoid capital gains tax (CGT) on trades, remove VAT and slightly lower costs.

However, she added while this does solve those problems, it also raises the question of how the unitised DFM is any different from standard multi asset fund.

Ms Ball commented: "The adviser needs to be very aware of what additional benefits it has, if any, that are appropriate for their client for the extra cost."

But according to Lawrence Cook, business development director for Thesis Asset Management, outsourcing can bring several benefits to an advisory firm.

He outlined these as:

1) Improve profitability.
2) Grow the business.
3) Enhance client care.
4) Deliver consistent outcomes.

Mr Cook commented: "The improved profitability comes from opportunity costs and the cost to serve. When the adviser is not using a DFM, the firm has to commit to work to support the investment solution.

"This is likely to mean research, updating the advisory model on the firm's systems and updating the individual client portfolio, which can often involve administration that requires the client's interaction.

"Time and resource spent on the above is time and resource that could be spent on something more revenue-generative, such as spending time with clients, winning new work and networking, for example."

Despite her concerns over risk and cost, Ms Ball agreed there were "definitely benefits" to outsourcing to a DFM but only "for the right clients".

She added: "For those with specific requirements, the ability to bespoke the selected investment strategy to individual clients’ requirements can result in a personalised service the client really values.

"This can be specifically including certain assets, like a sentimental shareholding, or specifically not including assets about which the client has strong feelings."

Simoney Kyriakou is content plus editor for FTAdviser

CPD feature: Is outsourcing all it's cracked up to be?

By reading this feature you will:
* Understand why outsourcing has become popular.
* Learn how this might affect risk and responsibility.
* Ascertain how to demonstrate TCF in investment advice while keeping costs low.

Outsourcing investment work is now commonplace across the financial advice profession.

According to Schroders, last year more than half of financial advisers delegated the task of looking after client portfolios to asset managers.

A separate survey, conducted by consultancy firm threesixty, put this figure closer to 90 per cent.

Many in the trade, regulators included, claim that this shift to outsourcing makes perfect sense, mainly because it frees up advisers to focus on their core skill of financial planning and leaves the arduous job of asset allocation to experts with far bigger resources.

It also helps advisers to satisfy grueling regulatory requirements. While most financial planners are qualified to pick investments on behalf of clients, sweeping regulatory changes mean these choices are increasingly coming under greater scrutiny.

On one website, several advisers agreed there is little point in clients paying an IFA for personal advice if all the important decisions are going to be outsourced.

Daniel Liberto

According to James Rainbow, head of UK financial institutions at Schroders, a big driver for outsourcing was the advent of the centralised investment proposition regime (CIP) and the requirements it puts on advisers.

He says: "Ensuring that an adviser has a clear process and that it can consistently be applied across advisers in the same firm can be challenging if advisers are effectively picking funds on behalf of their clients.

"Clearly there are governance challenges with outsourced relationships of any kind but the general rise in professional standards for investment selection (both in and outsourced) is a good thing for clients."

However, not everybody agrees that outsourcing ultimately favours the client. Most of this distrust has been aimed at discretionary fund managers (DFM), which generally take care of all day-to-day investment decisions – and have historically charged a fortune for doing so.

Plenty of advisers have grown tired of rules forcing them to keep evidence of every single decision – and seeing investments go up in smoke because clients forgot to respond to a letter requesting their authorisation to sell holdings ahead of the rest of the market.

DFMs offer to ease these rather large headaches, but do not always come cheap.

The other main alternative, model portfolios, have similarly attracted a fair amount of criticism.

Although much more affordable than bespoke DFM services, these pre-constructed investment funds, targeted to meet a specific risk profile and mandate, have been lambasted by some in the profession as another way for financial advisers to shoe-horn clients into any old one-size-fits-all vehicle.

These various observations have sparked plenty of interesting debates across internet forums.

In a heated exchange on one website, several advisers agreed there is little point in clients paying an IFA for personal advice if all the important decisions are going to be outsourced.

Another added that the idea of losing his most lucrative source of revenue – managing money on a regular basis – is baffling, especially as his clients really value their quarterly updates.

Greater transparency needed
Chartered financial planner Philip Milton argues that this type of mentality is precisely why advisers should be encouraged to outsource.

He believes leaving the difficult task of asset allocation to the experts can create better transparency and put a stop to what he calls “semi-amateur investment people selling the best performing funds of yesterday”.

In his view, these benefits are worth every extra penny that outsourcing companies demand, particularly as portfolios enjoying daily oversight should compensate by delivering greater returns.

“The client thinks the adviser is managing his investments,” he says. “Many of them perhaps ‘play’ at it, shuffling a few things for some transactional charges once a year at the review or so instead of ‘proper’ investment management.

"Therefore, you could say that the advisers who do outsource are doing the right thing for their clients – having someone to oversee the investments all the time.”

Time is scarce
Outsourcing advocates argue that the depths of research and growing amount of regulatory reporting requirements needed to make sensible investment decisions on behalf of clients are no longer always possible to achieve effectively.

That, and research showing that clients reportedly value face-to-face time with their adviser above everything else, has prompted some in the profession to reassess how they run their business.

I’m thinking why do I want the hassle of building my own portfolios, which could be more volatile?

Minesh Patel

Minesh Patel, chartered financial planner at Finchley-based EA Financial Solutions, lists a number of challenges that advisers now face when investing client money.

His chief qualms include navigating various share classes, assessing regular management changes and performance records, together with the tiresome task of filtering through client portfolios to establish who qualifies for capital gains exemptions.

Each of these core responsibilities, Mr Patel adds, rob an adviser of precious time he could otherwise be dedicating to better organising client finances.

Clients love cheap and cheerful model portfolios
So why all the criticism? According to Mr Patel, people who actively build portfolios always think they can do better than the professionals, and are often only proved wrong during a market downturn.

Mr Patel prefers instead to use model portfolios built by big investment funds and claims his clients are often overjoyed to hear that one of the “best financial institutions in the world” is looking after their money.

“Clients have more confidence in you if you have the conversation that you are very good at certain aspects, the financial planning, but the investment aspects you want one of the best financial institutions in the world looking after,” he says.

“I want to deliver plus inflation returns regularly without my client having undue upset or worry and that, quite frankly, I’m achieving through model portfolios. So I’m thinking why do I want the hassle of building my own portfolios, which could be more volatile?

"Vanguard shoots the lights out of most things, that is, its Vanguard LifeStrategy portfolio. Not only has it been a solid performer. It has been an outstanding performer and kept the costs very, very low. That is a difficult combination to argue against.”

What’s to stop clients from going direct to the DFM?
Mr Patel’s praise of outsourcing poses a serious question for advisers. If clients learn that their money is now being managed successfully by other professionals, they might, in theory, opt to cut out the middle man and go directly to the source.

Robin Beer, head of intermediaries at Brewin Dolphin, says his company, which offers model solutions and bespoke DFM, draw up contracts to reassure advisers that their clients will not jump ship.

These legal agreements often mean that Brewin Dolphin seldom knows who is the client on whose behalf they are investing.

But there is also a question of risk and responsibility. Who is responsible for the end client? The DFM to whom an adviser has outsourced, or the adviser who provided the advice?

Mr Beer calls this a delicate topic. "Who takes legal responsibility when an outsourced investment goes sour?" he asks.

In previous years, professional indemnity insurers have criticised outsourcing models as difficult to investigate when customers allege foul play.

Brewin Dolphin’s head of intermediaries reckons the process of identifying whether the adviser or the provider is to blame is actually quite simple.

“The adviser will come to us on behalf of a client with a particular mandate, with risk parameters, etc,” says Mr Beer. “Our job, our regulatory obligation, is to manage a portfolio within the mandate and parameters set by that adviser.

“If we, for whatever reason, do not do that and there is a complaint, then absolutely we are on the hook for that investment advice. Obviously, the adviser is on the hook for the financial advice, the suitability of the service, the risk category and everything else.”

Weighing up the costs
Even if advisers are blame-free should a DFM go rogue, some in the profession worry that this added comfort will be more than offset by complaints about the extra costs of these services.

Many agree that outsourcing to the experts should lead to greater returns for clients, but are also mindful that these earnings might then be eroded by the additional fees commanded by DFMs.

Mr Beer argues that the DFM market has grown much more competitive in recent years, helping to bring down costs and provide solutions for even the most fee-conscious adviser. Not everyone agrees with this assessment.

"While the intention may have been honourable by outsourcing to expensive active fund managers or DFMs, they may be seriously damaging their client’s wealth,” says Paul Gibson, managing director of Granite Financial planning.

"Total expense ratios for active funds have remained stubbornly high, as highlighted in the recent FCA paper on the asset management industry, and turnover costs, if known, can substantially add to these.

"Advisers outsourcing investments need to be very mindful of charges as these can be eye-wateringly high if not carefully monitored.

"Fees are increasingly being scrutinised and if an IFA is outsourcing investments and not offering a full financial planning service, including cashflow modelling, I would not be surprised if clients begin to question their value.”

Cheaper alternatives
Like many of his peers, David Gibson, chartered wealth manager at Gibson Financial Planning, believes there is little value left in advisers dedicating endless hours of their day to picking funds.

But he is also conscious about the costs of DFMs, which is why he has devised a different strategy aimed at satisfying both his clients and business needs.

Gibson Financial Planning pays industry consultant Finalytiq to sit in on the firm’s investment committee, where it chips in with research and analysis ideas.

Mr Gibson claims that this external expertise, which is billed directly to the company, rather than charged to each client’s portfolio, has provided useful input and drastically reduced management fees.

“We run in-house model portfolios set up and monitored by our investment committee,” he says. “The guy we pay to sit on our investment committee, Abraham Okusanya, assists with our research and we pay him directly.

"In our case, we specifically were interested in reducing further the investment costs of our portfolio for our clients. Since Mr Okusanya came on board, the portfolio management fees have almost halved."

Daniel Liberto is a freelance financial journalist.

Cost fears of using discretionary fund managers are overblown

Adviser concerns that discretionary fund managers will detract from their business and prove far too expensive is a myth, according to Lawrence Cook.

The business development director for Thesis Asset Management said some advisers have expressed caution over using a discretionary fund manager (DFM) because of a perceived high cost to using one.

He commented: "It is a myth that DFMs, as part of the service, make for a more expensive service".

According to Mr Cook, while there is a cost involved, quite often model portfolios on selected wrap platforms can cost a total of 1.1 per cent a year or even 0.7 per cent a year, depending on the type of portfolio and whether it is using active fund managers or a passive strategy.

His comments came as advisers taking a Talking Point survey with FTAdviser said they had a few concerns over outsourcing to a DFM.

Source: FTAdviser\/Talking Point poll 

Source: FTAdviser/Talking Point poll 

They expressed some level of caution over whether it was a service worth paying for, given there could be some issues over who will end up owning the client and whether the investment choice was good enough.

According to 43 per cent of respondents suggested ownership of the client would be their biggest concern, followed by 24 per cent who were anxious about the suitability of the portfolio.

Only 14 per cent thought the investment choices might not be good enough.

Moreover, Mr Cook said using a DFM could help the adviser improve their own profitability, from the "opportunity cost and cost to serve".

He explained: "When not using a DFM, the advisory firm must commit to work to support the investment solution he is running. This work is likely to mean researching, updating the advisory model on the firm’s systems and updating the individual client portfolio.

"The time and resource spent on the above is time and resource that could be spent on something that is more revenue generative, such as spending time with clients, winning new work and networking."

Simoney Kyriakou is content plus editor for FTAdviser