What to consider when ‘going discretionary’


Vicky PearceFor many firms running a centralised investment proposition, whether to remain advisory or take the steps to become a discretionary fund manager often comes up for discussion. Assuming additional permissions means extra responsibilities. But are they worth it?

When a client signs up to a discretionary mandate, their target portfolio (asset allocation) is agreed at the outset. The DFM monitors this on an ongoing basis and makes any switches necessary to ensure the portfolio remains within the agreed tolerances. This approach appeals to clients who prefer to be less ‘hands on’ in their investments and leave the decisions to their adviser.

From an internal admin perspective, the shift to discretionary will make firms’ switching processes more streamlined. It will also reduce the burden when switching investments held inside the discretionary mandate. For many firms operating an active CIP, this can be a key factor in their decision-making.

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One of the main benefits for a DFM firm is the speeding-up of the switching process. Enabling managers to react quickly in uncertain times brings huge benefits. Working with a discretionary mandate allows for timely decisions and the execution of orders to reduce the impact of significant falls. This is something even the most advanced advisory models would be unable to match.

So what are the drawbacks? In a word: compliance. When a client signs a DFM mandate, they are giving the manager permission to make decisions on their behalf. This is quite a responsibility and, if misused, could be harmful to clients and the firm.

Key compliance issues:

1. Investment managers – philosophy and procedures

To become a DFM, a firm must have at least two competent individuals who hold the relevant qualifications for discretionary management. At least one of these should always be available during business hours. This is to ensure the firm is not left without a qualified individual to trade should it be required. It is also vital that, before a firm considers ‘going DFM’, it has a clear investment philosophy that is professionally and accurately documented.

2. Icaap and Pillar 3

The Internal Capital Adequacy Assessment Process is an internal assessment of the key risks within the business/operating model to establish whether additional capital above the base requirement needs to be held for mitigation. This is a ‘live’ document and process that feeds in to the firm’s risk framework, and must be reviewed and updated at least annually.

Following completion of the Icaap, firms need to publish their Pillar 3 assessment on their website. The Icaap must be independently challenged, usually by the firm’s auditor or compliance consultants. To keep you on your toes, the FCA has a supervisor review and evaluation process that it actively implements.

3. Client reporting

Period reporting for discretionary managed portfolios has been around for a while. Client reporting was further enhanced with Mifid II, which brought the requirement to report falls in increments of 10 per cent within discretionary portfolios, as well as the need to complete and publish annual Regulatory Technical Standard 28 best execution reporting.

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4. Pricing and service proposition

Deep consideration needs to be given to how this new DFM service is priced. Firms already offering a CIP on an advisory basis often look to provide this new discretionary service without increasing their ongoing fees. If you are planning to charge more for this service, you will need to ensure the new proposition is sufficiently enhanced from the existing advisory model to warrant the additional cost.

If a client is receiving a service they are happy with and needs to sign a few forms a couple of times a year, why pay more just to avoid signing these forms? With the FCA increasingly looking at value for money from advisers, firms will need to consider how an increase in costs will be viewed.

It’s also worth considering whether a client base holds enough clients who would actually be attracted to an in-house DFM solution. Could a better solution be an outsourced one?

Finally, consider the additional cost of VAT to the client. Discretionary management is a VAT-able service; therefore, even if the firm’s fees remain the same, the cost of the service to the client will be increased by 20 per cent at current rates.

Becoming a DFM requires a commitment of time and cost at the outset, which are unlikely to be recouped for a number of years. Therefore, firms considering these additional permissions should view them as an investment in their business and service proposition, and be willing to absorb the costs rather than presume they can be passed on to the client.

Vicky Pearce is director of B-Compliant



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