Words on wealth: DFMs – what are they and how do they benefit you?

Published Jun 15, 2024


In line with global trends, the past decade has seen the rise of a new type of entity in the South African financial services space: the discretionary fund manager or DFM. If you invest through an independent financial adviser or planner, you may have come across the term. Or it may be that your investments are being managed by a DFM and you don’t realise that that is its generic name.

What is a DFM?

A DFM is an asset manager that services financial advisers by taking over the management of the advisers’ clients’ investments, including their retirement annuities, living annuities, tax-free investments, endowment policies, and preservation funds.

DFMs have a Category 2 licence under the Financial Advisory and Intermediary Services Act, which allows them to change the underlying investments in a portfolio at their discretion, without requiring the investor’s consent. Unit trust management companies operate under this category of financial services provider’s licence, and although some larger advisory firms have Category 2 licences, most independent advisers operate under a Category 1 licence, which allows them only to advise on and sell you financial products.

DFM services range from providing advisory firms with proprietary investment research to bespoke management of clients’ portfolios on linked-investment service provider (lisp) platforms to offering a range of in-house portfolios that cater for different investor profiles.

Although underlying investments in the in-house portfolios would typically comprise a blend of actively and passively managed unit trust and exchange traded funds, DFMs may access alternative investments such as hedge funds, private equity, and infrastructure projects in select instances.

Benefits of DFMs

Alexforbes launched its DFM Investment Solutions in April. John Anderson, executive in charge of solutions and enablement at Alexforbes, spoke to me about the benefits DFMs bring to both advisers and their clients.

“Until now, financial advisers have given advice regarding financial planning aspects – budgets, savings goals, tax-efficient investment vehicles – but they have also had to choose the investment strategy and select the asset managers for their clients’ investments. And many advisers have found that managing the overall investment process including picking the right managers consistently over time is a full-time job.

With offshore options expanding and the introduction of boutique managers specialising in certain areas of the market, it has become quite difficult, unless you’re a very large advisory practice to pick the right managers over time. That results in poorer outcomes for clients, but also results for the practices themselves in additional operational hassles.

Imagine an adviser with a couple of hundred clients, and each client is invested differently. All the operational and compliance issues would be extremely cumbersome. In response to this, advisers have appointed DFMs and outsourced to them the decisions on which asset managers to pick and the operational issues around reporting and compliance,” Anderson said.

He said the adviser-DFM-client relationship can take a variety of forms. “An adviser may have clients on various investment platforms or lisps, and the DFM may then contract with the adviser to access and manage client portfolios on a day-to-day basis by sending instructions to the various lisps.

Alternatively, the DFM can offer clients access to its own pre-packaged portfolios. In other words, the DFM’s service can range from a partial one – larger advisory practices may use it only for a supplementary research function, for example – to a full investment management function.”

Costs and ‘churning’

There were two concerns regarding DFMs that I raised with Anderson: the extra layer of costs that a “middle-manager” of your investments would bring, and the possibility of advisers switching your current investments into DFM portfolios with some incentive to themselves – a practice known as “churning”.

“We as a DFM are fully independent of all asset managers. We blend the managers, and over time we need to show that that is adding value and that the total cost should be no more than if the adviser chose the managers.

“Large DFMs make use of their size and institutional status to negotiate lower investment fees, which makes space for the fees they charge. In some instances you can come in at lower cost than one would investing at typical retail rates,” Anderson said.

“On the adviser’s side there is a saving as their administration and compliance costs come down, and that can be passed on to the client. At the end of the day, the fees shouldn’t be more but the adviser focuses on advising clients on financial planning aspects, which they are qualified to do, and investment professionals focus on the active management side of things,” he said.

On switching client’s investments into DFM portfolios, Anderson said there are many protections now in place for individuals. “Advisers can’t just switch your investments into a DFM. You have to agree to it. For discretionary investments in unit trusts, there are also CGT implications.

“The adviser needs to give you the option: either a once-off switch, and you realise the gain or a phase-in period or only new money going into the DFM portfolio. Switching would not incur CGT in vehicles such as retirement annuities, endowment policies and living annuities,” he said.

∎ Next week I will look at DFMs from a financial adviser’s perspective.

* Hesse is the former editor of Personal Finance.