Why advisers are outsourcing

Advisers have been increasingly using outsourced solutions for their investment clients. What are the drivers behind this and how might this trend develop?

Outsourcing investment management of portfolios has been gaining traction among advisers for many years.

One of the main reasons for this, according to Lawrence Cook, director of marketing and business development at Thesis Asset Management, is regulation.

The retail distribution review (RDR); the scrutiny on discretionary portfolios, suitability and risk profiling coming from the Financial Conduct Authority; and the Markets in Financial Instruments Directive (Mifid II) have all helped to hammer home the message that clients with similar requirements must get similar outcomes.

“To do this requires consistent processes and systems,” Mr Cook says. “However, implementing them without having discretionary permissions is very hard, so outsourcing largely solves this problem.”

Gary Kershaw, group compliance director for SimplyBiz, says that competence and the demonstration of this goes hand-in-hand with the regulatory requirements.

As a result, this is also putting more pressure on advisers to choose an outsourced model for their investment clients.

Mr Kershaw explains: “There is a need for advisers to hold specific qualifications and, although the qualifications and requirements themselves may change over time, the impact of taking them does not.

“For example, in terms of occupational pension transfers or long-term care, advisers must not only hold the relevant qualification but also demonstrate competence in these areas.

“If, therefore, you are a newly qualified adviser, it is not a given that you can immediately commence advising, as gaining the experience is often harder than passing the examination itself.

“These barriers to entry are driving firms to look at the referral route and unless there is a softening of these rules, I can only see this increasing.”

He adds that while advisers do have the necessary qualifications and experience, more advisers are choosing to refer rather than manage portfolios in house.

Economics of advice

Regulation isn’t just a stick, however, driving advisers to consider using a discretionary portfolio manager or choosing to use multi-asset portfolios on platforms.

As Barry Neilson, chief customer officer for platform Nucleus comments, there are positive drivers, not least the fact advisers using an outsourced investment solution are finding it more beneficial in terms of adding value to the client relationship.

“Advisers are getting exceptionally busy and having to think about their business processes differently,” he says. “They are beginning to think long and hard about how they add value to their clients.

“In the old days, the focus was on investment and product selection. Today, advisers add value through understanding clients’ lifestyle aspirations and personal requirements.

“It’s more about financial planning and coaching, rather than products.”

Therefore, according to Mr Neilson, to enable themselves to focus on this more, advisers are looking to outsource different parts of their proposition and the investment management is an “obvious one” because of its complexity.

“Many advisers feel an experienced investment professional is better-placed than they are to help clients on investment selection,” says Mr Neilson.

Mr Kershaw agrees: “Many advisers are telling us they are choosing the referral route rather than doing it in-house.”

“Outsourcing to specialist DFMs decreases the burden of resources required for investment management and selection,” says Andrew Denham-Davis, business development director at Brooks Macdonald.

Mr Denham-Davis continues: “It also provides efficient access to investment research and, possibly, brings more efficient engagement with time-saving technology such as CRM systems.

“In short, an effective partnership should enable advisers and DFMs to focus on their specialist areas of expertise for the ultimate benefit of our mutual clients.”

Operating frameworks

Mr Denham-Davis’ comment about working together and ‘mutual clients’ is not one that should be glossed over.

According to David Gurr, director of Diminimis, one of the big drawbacks when it comes to advisers choosing to refer a client to the investment management services of a DFM is that advisers do not often check the terms of their agreement with the DFM.

This means they and their clients might not always be getting the best possible deal in terms of a great working relationship between the DFM, adviser and client.

Moreover, he warns that when regulated entities are working together to provide a service to the underlying investor, the responsibilities of each party must be made crystal clear, as this has implications in terms of accountability and responsibility for the adviser firm.

Mr Gurr explains: “The whole industry has misunderstood a lot of the basis of the operating frameworks.

“It’s not just a question of getting the right paperwork in place: advisers and clients must have legal certainty of the services being offered and in what capacity the adviser is working, especially if the adviser is working as an agent with fiduciary responsibility for the client’s money.

“Moreover, when you have two regulated entities – the DFM and the adviser – working together, they both have duty of care to the client. This is also misunderstood.

“Because of this, they should work closely together to ensure the suitability of the investment solution to the end client, in a way that is efficient, productive and with an interface that is as robust as you can make it.”

However, too often advisers simply sign the agreement without negotiating or even reading it.

Mr Gurr says during a series of seminars he held a couple of years ago, he asked approximately 300 advisers attending whether they had read all of the intermediary agreements given to them by DFMs, and only two said they had.

Given that Mr Gurr has seen at least 16 different types of outsourced frameworks being established by DFMs, he says it behooves advisers to discuss and negotiate before signing on the dotted line.

He says: “You can negotiate a service and advisers need to be looking at the operating framework and the suitability matrix.

“There is scope to negotiate and advisers need to push back more, as otherwise the adviser will be totally exposed.”

Post-RDR and post Mifid II this is especially the case, as advisers will need clarity over who is responsible if something goes wrong, and the client needs to know who is looking after their financial interests.

“Just as an analogy”, he adds, “if an adviser acts as client with a fiduciary duty to the underlying investor, they need control and oversight of decisions being made within a DFM.

“If they are putting tens of millions of client money into DFM arrangements without doing proper due diligence, it is like buying a house on the back of an estate agent’s particulars.”

As Thesis Asset Management’s Mr Cook states: “Outsourcing is not a one-size-fits-all [service] and advisers are discovering that, when they talk to asset managers, they can find a service that either fits off-the-shelf or something designed very much to the requirements of the adviser firm.”

In good hands

Moreover, there is a concern that a DFM might seek to poach the client – although Mr Gurr says this is rarely the case in reality – and therefore an adviser should make sure there are proper introducer agreements in place.

This point has been raised by Mr Kershaw, who opines: “A robust introducer agreement, including a non-compete clause, will ensure your existing relationship will be protected from a legal perspective.

“But I believe rather than weakening your relationship with clients, outsourcing can only strengthen it, as advisers will remain the conduit through which all clients’ needs are addressed, regardless of whether or not they fall into business areas in which you yourself have elected not to advise.”

This is why it is important for advisers to check the terms of their business arrangements properly with a DFM and negotiate in the best interests of both the adviser and the end client.

Mr Kershaw also advises to “check, check and check again” when it comes to ascertaining the risk of introducing clients to outsourced suppliers.

This goes beyond the mere due diligence: he suggests speaking to previous clients and other advisers who worked with that supplier, to make sure an advice firm has a “full understanding of how the service provider will work with your client".

“If you still don’t feel sure your client will be in good hands, then do not make the recommendation.”

Cost and clarity

Other potential concerns that have been raised include cost, as post-Mifid II, the breaking-out of all aggregated costs and charges on a client’s investment portfolio might give rise to questions over why the adviser has suggested putting the client's money into a DFM service via a platform.

Mr Neilson explains: “Advisers need to consider the impact of fees. In a low-return environment, the overall cost to clients of advice, the platform and the investment solution may begin to look top-heavy, so advisers need to manage this.

“We’ve seen some advisers who liked the theory of outsourcing to a DFM but after crunching the numbers, they have realised the DFMs aren’t necessarily generating the higher returns than the advice firm itself was generating.

“So, in that case, what is the client paying for?”

Mr Gurr adds: “There is a perception that DFMs can be expensive but these additional costs are coming down.

“In particular, if you look at some of the services that can be provided by robo-advice, for example, those DFMs using technology well to keep costs down and deliver an enhanced service will help keep fees under control and improve efficiency.”

Forward look

So what might be in store in the years to come? Certainly there will be more regulatory scrutiny, as far as Mr Denham-Davis is concerned.

He comments: “New regulations have already had implications across the industry and regulatory changes will affect a number of aspects of private client investment management.

“This means both advisers and the DFMs to whom they outsource will need to meet more stringent requirements.”

Such requirements could include:

1) Frequency of reporting.
2) Suitability.
3) Data protection.
4) Costs and charges.

Tougher requirements has been reiterated by Mr Kershaw. “While there is no single piece of regulation on the horizon at the moment which specifically relates to outsourcing, regulatory change can affect the prevalence of outsourcing among advisers.

“I imagine regulation will continue to hasten the growth of the number of advisers now choosing to outsource.”

Mr Denham-Davis adds: “For advisers, this will increase the need for a robust, structured due diligence process, and opportunities for successful partnerships with DFMs, where complementary skills and expertise can work in combination to achieve the optimum outcome for clients.”

“I anticipate more movement from IFAs towards DFMs”, says Mr Gurr, especially as technological advances make DFM services cheaper and more efficient.

Mr Cook agrees: “Advisers are now keener than ever to ensure clients receive the service they sign up for.

“If the IFA proposition says for the adviser charge a client gets a full annual review, then the adviser needs to ensure they have the scope to do so. Outsourcing provides the breathing space to focus on financial planning, not administration.”

And for Mr Neilson, it “all comes back to due diligence” and making sure that, in the future, the DFM recognises the underlying needs of individual clients.

He concludes: “The onus is on advisers to have a process for clients that are not suitable for DFMs, and to put appropriate, alternative investment solutions in place.”

Simoney Kyriakou is content plus editor for FTAdviser