One of the big advantages that discretionary fund managers (DFMs) offer to financial advisers is their ability to use a range of tools in their portfolio construction. This allows them to add value beyond just using traditional funds in traditional asset classes.
Speaking during a panel discussion at the 10X Think Investing conference this month, chief investment officer at Equilibrium, Kamini Naidoo, said that DFMs today have a lot more levers they can pull in helping clients to reach their objectives.
“For example, we can decide to execute through active, passive or systematic strategies. And we can execute through traditional markets or use alternative investment strategies,” Naidoo said.
She added that the ability to use different tools also extends beyond just what goes into portfolios.
“We now use AI as an input into our tactical asset allocation view, for example,” Naidoo said. “That makes our decision making more robust and ensures we are factoring in more aspects.
“We also have better data insights into the portfolio through technology. We are able to get a more holistic view on how we think about risk or how we consider positioning, and we are able to respond quicker when we need to act.”
She said that having these additional tools has been important in the low-return environment of the past few years.
“Traditional alphas have come under pressure over the last seven years,” Naidoo said. “We have done a lot of work on what a strategic asset allocation can deliver, and we think you can get to 75% of our outcome on average through strategic asset allocation. We need to solve for that extra 25%, and alternative strategies are one of the key ways you can bridge that gap.
“Locally, that is largely through equity and fixed income hedge funds. Within a Regulation 28 portfolio we can allocate up to 10% and we maximise that as much as we can. We work that out in conjunction with the advisor.
“In global portfolios we also have access to listed infrastructure, which gives the portfolio added stability and offers inflation protection. Provided those alternative return sources are aligned to your targeted outcome, there is definitely a place for them.”
The primary method for DFMs to deliver these solutions is through model portfolios on LISP platforms. However, as Morningstar Investment Management’s head of investments, Sean Neethling noted, this does sometimes come with challenges.
“The economics of running a platform business are challenging, and it’s very difficult to run them without scale,” he said. “While the number of options can somewhat restricted, it’s incumbent on us as allocators to solve that for clients.”
Portfolio manager at Naviga Solutions, Eben Louw, added that DFMs also have to navigate other challenges in building solutions on platforms, particularly when different clients are using different Lisps.
“Firstly, in terms of trading or implementation, certain platforms we can implement changes in a few days, while others we can only rebalance once a month. That leads to a potential misalignment between portfolios when executing changes, which makes tactical asset allocation very tough.
“In terms of fund selection, a lot of platforms don’t list all of the funds we would like to see,” Louw added. “They often don’t have a lot of boutiques, and we like to blend larger managers with boutiques and passives. Again, that potentially leads to a bit of a misalignment. We look for alternatives to standardise solutions across Lisps, but in certain cases you can’t execute your preferred portfolio across all the platforms.”
He also finds that accessing alternatives can be difficult.
“We are pretty active in using hedge funds in our client portfolios, but certain LISPs don’t offer hedge funds, and we are often limited in how we can use them,” Louw said. “That said, the bulk of our assets are on platforms that are more flexible and don’t have that problem.
“We try as much as possible to engage with platforms to help them develop, but it is a problem facing all DFMs. If you think about the dynamics of portfolios of the future, you need LISPs that are both dynamic and flexible and that can cater for these solutions.”
Equilibrium’s Naidoo said that some of these issues can be solved through using unit trust structures, where availability of funds and even ETFs is not a problem. However, DFMs are currently unable to use hedge funds in a collective investment scheme (CIS).
“There is a place for both structures,’ Naidoo said. “A few years ago, we saw a shift from CIS funds into models, largely driven by need for greater look-through. Globally, we’re now seeing a shift back towards CIS funds. It’s going to be interesting to see how that travels into our local market.”
Morningstar’s Neethling said that what remains most important for the DFM is ensuring that clients are invested in the right mandate .
“We now have access to different tools that are more robust than they were in the past,” he said. But we always have to be aware of the outcome we are delivering for clients.”