South Africa’s discretionary fund managers (DFMs) are expected to focus on passive indexation and alternative passive strategies, also called enhanced indexation, to optimise their model portfolio returns over the next two to three years.

In addition, many DFMs are concentrating on launching unit trust versions of their model portfolios and expanding into offshore market. I believes that there are two distinct evolving parts in a DFM business, namely model portfolios (being a combination of different funds) and single funds made up of different asset manager allocations.

For the uninitiated, DFMs offer investment services to both independent and tied financial advisors, so that these intermediaries can focus on providing advice (and not investment management) while ensuring that their clients’ funds are invested in cost-effective and risk-and-return-appropriate model portfolios.

These solutions are aimed at making advice practices more efficient when it comes to investment implementation, ongoing management of clients, and client feedback. The win-win for DFM, financial advisers and investors is a solution that is more attractively priced with comparable investment returns.

Old Mutual Wealth differentiates from other DFMs by focusing on asset allocation when structuring its model portfolios. We start our process with asset allocation research – but more importantly, we enhance this research by keeping the long-term real return objectives of our clients in mind.

By gaining a deeper understanding of the after-inflation returns those clients need to achieve, the DFM can include an appropriate balance of asset classes and risk within the model portfolio.

Once we have established an optimal asset allocation for our model portfolio we can go in search of asset managers – whether active, passive, or a combination of the two – to implement the strategy.

IFAs often interrogate me on the investment decision-making structures within a DFM. We work with a multi-management team that looks after assets in excess of R100 billion. Seven of the nine team members are tasked with asset allocation and manager research, with the remaining two dedicated to macroeconomic research and views. All decisions are taken based on both qualitative and quantitative information.

The former relates to the people, performance, philosophy, and focus of each asset manager. Quantitative information, meanwhile, includes assets under management and measures such as liquidity, performance, risk, and trading style.

Retail investors have two major focuses when it comes to their discretionary investments: fees and investment return. The burning question is whether DFMs simply introduce an additional layer of cost, over and above what an investor might pay for a balanced fund. I believe the DFM model solution has advantages in both the practicality and fee stakes.

When you combine asset managers that all look after balanced fund solutions, you create a situation where managers take opposite views and the asset allocation picture becomes blurred. It is thus better to put one party in charge of the asset allocation and seek manager diversification at an asset class level. And that describes how Old Mutual Wealth approaches the challenge.

Because we are not paying every party for both an asset allocation and stock selection function, our DFM solutions are cost-effective compared to a typical balanced fund, and they can also control risk from a primary nexus.

Roland Gräbe is head of discretionary fund management at Old Mutual Wealth.

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