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Recommending DFM Portfolios: The Key Issues

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Why does recommending DFM make sense for both client and adviser?

Great Client Outcomes

What’s best for the client will, in the long and the short run, be best for the adviser. There is win/win in an approach that makes good investment outcomes more likely.

This starts with risk assessment. Behavioural science tells us that clients have a natural, individual level of risk tolerance that will remain consistent over long periods of time. They also have an individual level of loss capacity which is influenced by their personal circumstances.

Both tolerance and capacity can be reliably measured. Parmenion’s own risk profiling tool has been independently assessed by Edgecumbe Consulting.

The scores it provides are mapped to actual portfolios of thousands of individual clients, giving the DFM investment manager anonymised data to consider in maintaining their strategies, aligned to multiple investment styles. They will use this data, with their understanding of current markets, to make sure the asset allocation of portfolios is consistent with the tolerance and capacity of each client. When changes occur, whether in asset class behaviour, fund manager performance or governance, an update can be made across a very high number of clients. A DFM investment team are totally focused on markets and investments and provide year-round, hour by hour continuity of monitoring and assessment. This is a great strength, and a major factor in the final client outcome.

Let’s compare this with a ‘client by client’ approach to asset allocation and fund selection. We’ll assume, for the sake of argument, that risk profiling has taken place, and a model that links to particular levels of risk created. When the client is being asked to approve each individual investment, recommendations ‘accepted’ or ‘rejected’ can nudge the portfolio away from its core model or asset allocation over time, increasing the risk of portfolio drift. Periodic withdrawals and additions of capital can have the same effect.

There’s an interesting behavioural issue at work here. Consider a client ‘anchored’ on receiving fund recommendations for a £50,000 advisory portfolio. Would they value a bigger version of the same portfolio to handle a £250,000 windfall – or expect 5 more, very different fund recommendations?

If they want ad hoc withdrawals from their £50,000 portfolio, what is more likely to happen? Is it a little taken everywhere, as with DFM rebalancing, or the sale of a single holding to keep admin simple? Which is better for the client?

The key to client success is a diversified portfolio aligned to their personal risk tolerance and loss capacity – and that is precisely where DFM delivers value for advisers.

Key Issues: validated risk assessment tools, choice of portfolio style, mapping risk score to asset allocation, speed of reaction to market and investment changes, eliminating portfolio drift, efficient portfolio rebalancing, anchoring client on the key issue – control of risk.

Professionalism

Professionalism means confidence in being able to deliver the outcomes we know customers are seeking.

A good starting point is considering the type of problems most clients will need help with and having a set of dependable solutions at hand.

A classified segmentation of your clients by size or need means general enquiries can be answered by everyone in your business, not just advisers. When a client is in a service segment with similar clients, a professional investment proposition will precisely and effectively adapt their investments to their needs.

Professionalism also means knowing how to steer when there are bumps in the road. Imagine an adviser who combines a financial planning and tax optimisation proposition with a bespoke investment service. What happens when his investment recommendations are failing to deliver the outcomes demanded?

When this happens with a DFM, every adviser knows immediately what they can do. The DFM’s speed of response, continuity of oversight and depth of research kicks in and, if necessary, they can move the mandate to an alternative manager. That’s impossible, or potentially embarrassing, if your own ideas are at fault.

The challenges in a “one stop shop” approach are compounded by the need for you to maintain expertise in every area. Tax is a large enough field alone, let alone pension legislation.

Having DFM support in the world of investments can be invaluable in your suitability monitoring. Continuity of oversight means keeping on top of CPD and the day to day swings of markets while maintaining the ongoing Research and Due Diligence endeavour of individual fund managers. Parmenion allocate this task full time to a team of eight – a measure of the depth required across multiple investment styles for a sound basis of research evidence.

Key Issues: research effort, continuity of review, TCF by customer segment, optionality to switch provider, qualifications, client esteem for focused expertise in tax/planning/review.

Business Logic

We’ve seen how recommending a DFM portfolio can take care of the client outcome and establish the professionalism of the adviser.

But what is the business logic for the advice firm looking for a higher, more consistent ratio of revenue to cost? Simply this: the cost to an adviser of maintaining a suitable DFM portfolio for their client is significantly reduced.

The work done to support this responsibility forms part of the charge made to the customer by the DFM, which the adviser has worked to minimise. The costs of maintaining an ongoing research and monitoring capability of individual funds or in-house models to any standard of professionalism are avoided.

On the revenue side, the predictability and level of adviser remuneration is simplified. The key pieces of work for the adviser are the initial portfolio recommendation and the periodic review, which checks that changes in personal circumstances and/or unexpected portfolio returns do not require a change to risk level or investment style.

Thanks to the segmented nature of this service, price negotiation is unlikely to be a common issue with standard clients. Perception of value will be high.

They say ‘knowledge is power’ and this is definitely true in the way DFM delivers Management Information (MI) to advisers. It provides clean lines to support planning, budgeting and, importantly, business valuation through key data. One of the real and acute costs to running clients on a bespoke ‘one at a time basis’ is that it becomes much harder to answer the question: what is your business is really worth?

Key Issues: cost to maintain, revenue structure, maintenance costs, resulting margin, cost to customer, TCF MI, price of true bespoke.



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