The Quiet Revolution

Centralised investment propositions (CIPs) continue to be a big deal among the advice and planning firms we speak to. Within that, outsourcing the running of model portfolios to a discretionary fund manager (DFM) has become an attractive way for some firms to deliver investment management at scale, while at the same time allowing the business to major on the financial planning part of the service instead.

But as the market has grown and evolved, so too have the questions that advisers and planners have to ask themselves, particularly with more regulatory scrutiny coming down the track.

So how did the model portfolio service of today come to dominate? And what are the factors firms need to be aware of in making their initial and ongoing assessments of suitability?

The market in context

Our research tells us that many firms use a CIP to some degree. In our most recent wave of State of the Adviser Nation (SOTAN), 88% of respondents said they use a CIP – that’s come in at around the same level over the four years we’ve been tracking this stuff.

There is some complexity within that headline figure, such as firms that have some flexibility within their CIP to take account of ethical, active, passive or blended segments.

It’s also worth spending a bit of time on what we mean by a CIP. We define this as a standard process which sees a range of investments repeatedly recommended to clients with similar needs.

This could mean:

• Model portfolios built and run by advisers themselves.
• Model portfolios run by a DFM.
• Outsourcing to a DFM for bespoke portfolios.
• Risk-rated multi-asset funds.
• Provider-specific ranges available on a particular platform or product.

Add to this the fact that fewer than 10% of the firms we spoke to hold discretionary permissions. So why has the market shaken out this way?

The regulatory drivers

In the wake of the RDR 10 years ago, investment management became one part of a ‘holistic’ advice service. Some firms decided that wasn’t for them, and dedicated their service to financial planning only. But others went a different route, building and running their own model portfolios and selecting funds. For specialist firms who have that level of expertise, this continues to be a successful strategy. Yet there were also firms who, as time went on and as client numbers grew, found it increasingly difficult to maintain their in-house investment proposition.

Then, in 2018, MiFID II came along. The additional requirements of individual ongoing suitability assessments and the compliance burden of extra costs and charges disclosure meant that rebalancing or swapping out funds became harder and harder for advisers to manage. Clients who failed to reply to requests to change investments would get left behind in old models, and the investment make-up across clients who had started in the same place ran the risk of becoming out of control.

One possible solution to all this is for firms to take on discretionary permissions themselves. As mentioned, this route appears to be in the minority. On the one hand, it gives firms the freedom to make those investment calls about rebalancing and the like without needing to trouble the client. Yet on the other hand, having DFM permissions can require a significant amount of work. Firms have to think about things like how the discretionary part of the business is structured, the impact on professional indemnity cover, whether it requires additional staff and how to manage any potential conflicts of interest.

Another option is outsourcing the running of model portfolios to a DFM. Rebalancing is done in bulk by the discretionary manager, and the adviser (so the argument goes) is freed up to provide value elsewhere.

"In the wake of the RDR 10 years ago, investment management became one part of a ‘holistic’ advice service. Some firms decided that wasn’t for them, and dedicated their service to financial planning only. But others went a different route, building and running their own model portfolios and selecting funds. For specialist firms who have that level of expertise, this continues to be a successful strategy."

“A different world”

The MPS/DFM market seems to be broadly working well for both clients and advisers. Yet the growth of the market means there are a LOT of providers to choose from. A quick comparisons search within our Analyser software shows there are around 180 DFMs available across 25 platforms, and there will be many MPS permutations that sit underneath that.

As my fellow lang cat Mike Barrett says: “It’s suddenly become a very saturated market. The cost of accessing these MPS solutions is also going down, which is clearly good news for clients. Plus there’s a lot of choice and availability. So it may be that three or four years ago an adviser would have looked at the cost of a DFM model portfolio service and decided against it. It’s a different world now.”

For some firms, outsourcing to a DFM for MPS makes sense, with a clear separation between planning and investment management. Advisers and planners

still have to have a keen eye on that total cost of ownership though. For example, if a client has gone from an in-house model portfolio to an outsourced model arrangement, the investments may have pretty much stayed the same but yet the client may be paying an extra 15 basis points for the privilege.

Consumer Duty and value for money

As advisers and planners will attest, the next big regulatory project is never far away. The one looming on the horizon is the FCA’s Consumer Duty proposals, with final rules expected by the end of July.

Consumer Duty is set to have wide-ranging implications across financial services, but we think there’s two big knock-on impacts that relate to the DFM MPS market specifically.

The first is around client segmentation. Advisers have heard a lot on this as part of complying with product governance (PROD) rules, but Consumer Duty reinforces how strongly the regulator feels about it. Firms using a model portfolio service have to be really clear on their segments, which types of clients that service is and isn’t suitable for, and making sure their approach is documented and monitored.

The second is around value. The FCA talks a lot about “fair value for products and services” in its Consumer Duty papers, and has also called out price and value as one of four major outcomes it wants the Consumer Duty to achieve.

Advisers and planners need to establish the value of their own fees plus that of whole value chain, including platform, investment management and underlying fund costs.

Firms will likely be across all this as good practice. But Consumer Duty makes this an even more explicit requirement than it has been – and advisers and planners will have to make those judgements about suitability and value on an ongoing basis.

For more support from the lang cat on due diligence and suitability, visit

www.platform-analyser.com

where you can also find out more about our new MPS Analyser service.