Key DFM due diligence steps and the role of provider-level assessment as part of this process

The requirement for, and benefits of, due diligence

It is in the best interests of advisers to carry out robust and repeatable research and due diligence exercises when selecting partners for their business, including outsourced investment specialists such as DFMs.

It is in the best interests of advisers to carry out robust and repeatable research and due diligence exercises when selecting partners for their business, including outsourced investment specialists such as DFMs.

These exercises should be done to facilitate best practice within the adviser business and, crucially, to support the delivery of good customer outcomes. Furthermore, the regulator remains keen to see evidence of deeper and more engaged due diligence being carried out by advisers.

In a market experiencing great change, due diligence will continue to increase in importance and is something which needs to be done when first identifying and selecting DFM partners, and then revisited on a regular basis.

By adopting robust due diligence processes, adviser businesses will put themselves on the front foot with regards to sustaining winning relationships with DFMs, delivering positive customer outcomes and being able to better respond to change and challenge.

Putting a due diligence framework in place

There are a variety of ways in which an adviser business might go about their research and due diligence. In order to establish a robust and repeatable due diligence framework when selecting DFMs, and to create a supporting audit trail, AKG proposes a balanced four-step process which can be tackled in any order and covers:

Step 1 - Proposition research and analysis

Step 2 - Investment performance and style analysis

Step 3 - Operational capability and service delivery

Step 4 - Provider assessment

A suggested four-step framework

Step 1 – Proposition research and analysis

The nitty gritty research and analysis required to compare what's available in terms of the proposition(s) being marketed by DFMs, i.e. What does the customer need? Who does what and how does it compare? Items may include analysis of:

  • Type of portfolio solution - BPS, MPS, unitised
  • Features and composition of portfolio service
  • Associated terms and conditions • Cost of service versus value provided
  • Accessibility of portfolio service via relevant product wrappers/platforms.

Step 2 – Investment performance and style analysis

When selecting a third-party investment specialist, an assessment of their performance credentials, and an understanding of their investment approach and style, will inevitably form part of the process for advisers:

  • Gain an understanding and be comfortable with investment approach and style
  • Seek out relevant past performance and request regular ongoing performance data
  • Match portfolio service to agreed risk parameters for customers
  • Monitor portfolio service performance against objectives set at outset for the customer.

Step 3 – Consideration of operational capability and service delivery

Advisers should also try to get a feel for the infrastructure in place within DFM businesses to support the ongoing delivery of portfolio services to customers and advisers. Items may include consideration of:

  • Resource, staff, teams
  • IT systems
  • Risk management systems
  • Security of customer data and assets
  • Online/offline servicing capability
  • Integration with other relevant systems in the adviser business, i.e. CRMs, platforms.

Step 4 – Provider assessment

Beyond the headline level of assets under management held, advisers should seek to understand more about the DFM business that customer assets will be entrusted to by considering the following:

  • Business structure and senior management team
  • Core financials and capital position
  • Financial strength and sustainability
  • Operations, governance and risk
  • Image and strategy
  • Distribution capability.

Contextualise selection through suitability testing

A reminder on the balancing act at play here in terms of suitability. AKG feels that, ideally, suitability should be tested on two levels when selecting DFM partners:

1) End customer level (individual customer and/or customer segments) – FCA commitment to ensuring good customer outcomes means that identifying and sourcing suitable solutions for customers will continue to be a crucial requirement.

2) Adviser business/service(s) level – Adviser businesses have worked hard to re-engineer their structure, processes and service proposition in preparation for RDR, and hence they should rightfully be identifying and selecting DFMs that can fit with this operational structure, style and focus.

It is vital that a logical and sensible combination of these suitability requirements is found. Otherwise there is a danger of over emphasis on solutions/partners fitting the requirements of the adviser business rather than those of the end customer, i.e. 'shoehorning'.

Contextualise against evolving market

Advisers should also seek to contextualise the due diligence process and the key considerations for their customers and their business considerations against the backdrop of an uncertain economic and political landscape, allied with an ever-changing financial services marketplace.

Where to go for due diligence support

Carrying out robust research and due diligence exercises can be resource/time consuming for adviser businesses and so advisers may need to seek support:

  • Go direct to DFM with Requests for Information
  • Consider support from independent third parties
  • Trade bodies may help with guidance and educational resources on the subject
  • Advisers should also endeavour to meet representatives from potential business partners in person.

Introducing AKG's DFM assessment work

AKG is an independent organisation specialising in the provision of assessment, ratings, information and consultancy to the financial services industry. An independent company, AKG has provided detailed expert financial strength assessments (including ratings) and analysis to the UK financial services sector for over 20 years.

AKG's analysis draws on publicly available information, supplemented by other detailed information made available to AKG directly by providers.

Traditionally AKG's focus had been predominantly on life companies. However, in light of the growing impact of other entities and the underlying transformation in the financial services market in the UK, there has been increasing demand, from intermediaries in particular, to widen the scope of entities that receive specialist AKG assessment, including DFMs.

Overall, the aim of AKG's assessments is to provide independently evaluated information to assist in the choice of a service provider by the intermediary as well as to help in the understanding and appropriate development of the market.

In line with its core focus, AKG's assessment is primarily focused on financial strength. AKG considers that a major consideration for an intermediary, in considering a DFM is the comfort and assurance that can be obtained from an independent, external assessment.

It is an important component in seeking to avoid the operational complications and potential brand damage that would be incurred should a chosen DFM encounter any financial difficulties, suffer a restriction on necessary investment to deliver required service and investment expertise/ capability, or in some other way 'fail'.

AKG assesses financial strength using consistent methodology and objective measures wherever possible, and the detailed analysis of the company's particular strengths and weaknesses.

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