Some advisers claim that outsourcing investment selection reduces risk and the requirement to give suitable advice. We think that is wrong. Today I’ll make the case that regulatory responsibility sits with the adviser. I’ll also tackle MiFID II and the new duty to report a 10% drop in portfolio value — and I’ll challenge advisers to consider the OCF when comparing DFMs’ fees and charges.
Yes, these are heavy subjects for the dog days of summer. (To take the edge off, Platforum is offering a free summary of our model portfolios on platforms report. If you’re interested, please drop us an email.) For now, park your Pimm’s and consider:
>Regulatory responsibility sits with the adviser
Advisers perceive a reduction of responsibility – in particular for risk and suitability – as a driver of investment outsourcing. There is debate about whether outsourcing actually does reduce risk. We don’t think it does. We think the advisory firm can outsource the ‘function’ but not the ‘responsibility.
Phil Young has also highlighted this issue with typical punchiness, albeit for the DB transfer market.
>MiFID II rule about 10% drop in portfolio values
One of the requirements of MiFID II is for clients to be notified within 24 hours if a portfolio falls 10% or more. The requirement has caused confusion among advisers, platforms, DFMs and fund managers over who must take responsibility for the communication.
We conclude, after hosting a number of roundtables with advisers, platforms and DFMs in the past few months, that in cases where an adviser uses a third party DFM, the DFM has the responsibility but the platform will facilitate that communication.
DFMs running model portfolios on platform typically do not have client data, which in any case most of them don’t want for data protection reasons. Clients’ investments are managed at the portfolio level rather than the account level, so DFMs won’t necessarily know the performance for an individual’s account. Two DFMs we spoke to are requesting individual client data from platforms and advisers in order to comply with this new rule. Advisers still get nervous about DFMs trying to steal their clients. This won’t help.
Most platforms will facilitate reporting but they highlight the complexity of tracking the information and reporting portfolio falls to clients within 24 hours – particularly as many platforms don’t have email addresses for all investors.
More complicated is when advisers run models on an advisory basis. In those cases, is the adviser the portfolio manager? We think that unless the adviser firm has discretionary permissions it is probably off the hook. But this needs clarifying. We know of advisers and platforms that have interpreted this differently.
>Pricing
Advisers tell us that the most important factors when selecting a DFM are fees and charges. DFMs running on-platform model portfolios tend to break down their charges into an annual management charge (the AMC is the charge from the DFM to manage and run the model) and the cost of the underlying investments within the model – the OCF of the funds.
We analysed the fees and charges for the 18 DFMs most widely available on adviser platforms. We looked at a representative low, medium and high-risk portfolio from each provider and we focused on active portfolios to offer a fair comparison.
- We see a clustering of AMCs around the 0.30% + VAT (0.36%) mark with management charges ranging from 0.15% all the way up to 0.75%.
- Underlying fund OCFs vary widely too – riskier solutions tend to carry a higher OCF on the underlying funds – largely due to greater exposure to equities and higher transaction costs.
- The median total cost of a model portfolio service on platform is 1.05%, with total charges ranging from 0.50% to 1.54%.
This variance in the OCF and the total cost underlines the need for advisers to consider not just the AMC but the OCF as well.
>Looking ahead
We expect to see more unitisation of DFM models. It is generally cheaper and more suitable for managing income in drawdown. We also expect to see more passive or passive blended models and portfolios designed for decumulation.
I am off sailing in Canada for a few weeks. Model portfolios will be far from my mind, but the Platforum team will be publishing the Friday email throughout August. Have a lovely summer. You may now return to your Pimm’s.
In response to our newsletter, a legal expert provided us with this clarification on the FCA’s position:
- A suitability obligation under the FCA rules is technically only triggered by what in regulatory terms is considered advice or a personal recommendation, and this is technically only given on products not services. So if an adviser recommends a model portfolio or discretionary advice, there’s technically no suitability obligation under COBS or MiFID/MiFID II (although most firms in my experience tend to assume the obligation applies, for good TCF, relationship and other reasons).
- It’s not an outsource, because this is defined as “an arrangement of any form between a firm and a service provider by which that service provider performs a process, a service or an activity which would otherwise be undertaken by the firm itself.” The adviser generally can’t do the discretionary management themselves, so it’s not outsourcing to get someone else to do it instead.
- The third point is that, whether it’s model portfolios or bespoke portfolios, the manager has a suitability obligation when making day to day decisions to buy/sell – not/never the adviser.