There has been a boom in model portfolios services in the past few years, and their popularity on platforms continues to grow. But something is standing in the way of this progress and, left unaddressed, could potentially reverse their impressive growth trajectory.
Discretionary model portfolio services are a fairly recent invention, with the first one dating from the early 2000s. Since then, they have quickly grown in popularity.
A report from NextWealth and Criterion found that assets in discretionary MPS grew 28 per cent in the year to March 2024 to £123bn.
Advice firms have been quick to embrace MPS as investment solutions for their clients. The same research found that 44 per cent of financial advice professionals use discretionary MPS and 24 per cent expect to increase their use of them in the next 12 months.
Advice firms like using discretionary model portfolios because they simply do not have the time and resources to analyse the whole market for suitable investments and then actively manage them for each client.
The ability to outsource this to a specialist discretionary fund manager has freed up advisers’ time to focus on financial planning. No wonder then that inflows into MPS have swelled so quickly.
Models become more complex
As these models grow in popularity, they are becoming increasingly complex. Most DFMs run several different versions of their models, each of which might have different fee structures, share classes, fund availability and fund domicile.
This presents significant operational challenges, as the processes in place to manage them were not designed for such dramatic expansion.
Say a DFM has six or seven core models, the numbers of portfolios it is actually running, each with slight variations, could be many more as customisation grows. A DFM might be managing these portfolios across 20 different platforms.
The platforms themselves add another layer of complexity, as they will have their own processes for rebalancing and reporting.
Operational burden grows
The increasing use of DFM models is a good thing for advisers and consumers, but it has created an increased operational burden for DFMs, who are now having to manage multiple versions of models across different technology ecosystems, using different processes and with different rules and restrictions that are put in place by the platforms.
DFMs do not own the platforms so they cannot effect any change directly. They have to come up with workarounds.
One of these is labour-intensive manual checking. But, with a lot of operational intervention, the risk of error is higher and, of course, it also increases the cost of running that model.
Even if checks are automatic, there is potential risk and additional cost involved.
This then starts to chip away at some of the benefits to the consumer because the cost is not as low as it could be. The investor may end up out of the market in a rebalance transaction because a mistake has been made somewhere, which disadvantages them.
Whose problem?
As an industry, we may agree there is a problem, but whose is it to solve? Across the DFM, platform and advice world, there is a very distributed set of responsibilities. In isolation, everyone is probably doing the right thing, but it does not equate to a great solution overall.
