Blue Chip Issue 84

BLUE CHIP DFM mandate

BLUE CHIP DFM mandate some of the fund managers to have a capital protection or preservation mindset. In aggressive portfolios, we take more risk because we have the time and the investors in these portfolios don’t mind a bit of volatility as their focus might be more on capital growth than on capital protection. All investors in a portfolio get the benefit of decisions on the same day under a Category II licence. From a Treating Customers Fairly perspective, clients are all treated the same at the same time, which is a big advantage of partnering with a DFM. The complexity of legislation and the fact that FAIS has professionalised the industry has led advisors to partner with DFMs who manage assets on behalf of the clients. It is up to the DFM to understand what is happening in the market and how different asset classes are performing. What is the potential growth of the DFM sector? We have seen huge growth in the DFM industry both locally and internationally as advisors grapple with the increased demands on their time. The legislation requires Category II licence holders to have the necessary expertise to operate as such. This requires specific skill and training but also necessitates the required resourcing within a DFM to offer all the services. Although the market has grown, not all DFMs are equal. Some manage only in-house funds, some specialise in limited areas and others offer the full spectrum of Category II services from strategic and tactical asset allocation, manager research, strategy optimisation, quantitative tools, full attribution reporting and portfolio construction to MANCO services. There are Category II licences out there that aren’t fully resourced. In these instances, they often appoint a sub-investment advisor (or DFM) to help them in the areas where they may not have the necessary skill. For example, they might have asset allocation skills but lack portfolio construction skills or they might be good at identifying equity managers but are not skilled in the fixed income or hedge fund market. I think there is going to be consolidation. Another factor is how many of those are not necessarily true DFMs in that they do not manage third-party assets. In South Africa, there are maybe 12 true independent DFMs who manage on behalf of independent financial advisors and six of them are large. There are a lot of what I call in-house DFMs, who manage for their own network group type assets, that’s a little bit different. Do you think that there should be more consolidation? There is no doubt that the discretionary fund market is growing so if the percentage of assets that are managed by DFMs is increasing and advisors are starting to outsource more to DFMs, I think there will be opportunity for new entrants. But running an investment management business isn’t easy. Professional skills and tools are expensive and attracting assets is critical. One of the best tools to secure assets is a proven track record. I guess the challenge for new entrants will be in their differentiators. We need to remember that adding new model portfolios to platforms is costly and often leads to operational inefficiencies. Platforms are becoming increasingly hesitant to keep adding funds that don’t attract assets. This puts pressure on all investment managers and DFMs to make sure that they are bringing in the assets. For advisors and investors, more choice makes it even more difficult to evaluate the best option. In South Africa, we are spoilt for choice. We have phenomenal investment managers. The challenge is in identifying what each investment manager 26 www.bluechipdigital.co.za

DFM BLUE CHIP is good at and then determining whether their fund’s benchmark is aligned to the outcome that an investor is looking for. We have started to see consolidation across investment managers reaching an all-time high over the past few years, and the same is true of platforms. I believe there will be a point at which the industry will become too saturated and we will start to see consolidation. There is an opportunity for certain new entrants, but size is very important. DFMs with large investment teams but small assets are often not profitable. Investment teams cost money to run. They need sizeable assets, and I would argue that if they’re trying to compete with the larger DFMs, unless they are niche, you may find consolidation in that space. So, the small houses trying to compete with the larger independent DFMs are probably under pressure. Is the DFM’s service to the advisor worth the cost? Do DFMs generate investment alpha? If they are providing the benefits that the advisor is looking for then I would argue yes, but they should provide the service at an appropriate fee. There are a range of fees that DFMs charge and it is important to understand what you are getting for that fee. Just like you would evaluate an investment manager on their performance, you should evaluate whether your DFM’s portfolios are performing. Traditional investment managers and DFMs add value after fees so it is essential to look at the after-fee experience rather than before fees. An advisor needs to evaluate the level of benefits they receive. Are you getting strategic and tactical asset allocation, manager research, portfolio construction or is your DFM only giving you a couple of these? The DFM fee cannot be looked at in isolation, you need to combine the DFM and the underlying portfolio manager fees and compare the total to what you would pay if you bought the funds directly. The DFM market has grown so the ability to negotiate preferential fees with underlying investment managers has improved. If you compare the DFMs’ total investment charges to the charges that retail investors could get going directly to underlying funds, you will find that you are getting very good value for money. A DFM does charge a fee for this professional investment service, but it is not that fee in isolation – it is the total investment charge that needs to be compared and then the performance after all those fees. You need to look at how your DFM is performing. Are they generating alpha? You should compare this to how a traditional manager generates alpha. It is important to understand what you’re getting. Whether using a DFM or a fund, is the benchmark aligned to your objective as an investor? If you are looking to out-perform inflation, you need to ask yourself is that DFM, single manager or multimanager portfolio giving you what you are looking for or is the benchmark completely misaligned? Certainly, professional DFMs add value. It is difficult to compare them because not all of them have funds and fund of funds. Many execute through model portfolios and there isn’t really a formal benchmark survey for that. The DFM survey produced by The Collaborative Exchange is a start but certainly not enough. Not all DFMs participate and some participants do not include their full range of portfolios. I would love to see a more formal industry survey with strict minimum criteria similar to the institutional surveys produced by some of the asset consulting firms. Just like there are good investment managers and some not so good investment managers, I believe the same is true of the DFM industry, not only in South Africa but globally. Equilibrium Investment Management (Pty) Ltd (Equilibrium) (Reg. No. 2007/018275/07) is an authorised financial services provider (FSP32726) and part of Momentum Metropolitan Holdings Limited, rated B-BBEE level 1.