Discretionary portfolio management services promise a bespoke service based on your needs. But personal service comes at a price: it can be expensive and has certain tax disadvantages over traditional collective products. So is the price worth paying?
Seen as a bespoke, high-end service, in practice discretionary managers vary considerably in the level of customisation offered.

At one end of the scale are the traditional stockbrokers, where the fund manager acts as relationship manager and portfolios are tailored to each individual. At the other end is the approach where clients are slotted into one of a number of asset allocation models, which then forms the building blocks for their portfolio.

A range of options
Hargreaves Lansdown is an example of the latter. Its financial planning process determines into which of six matrices each client fits. The group uses its multi-manager process to form the building blocks of the portfolio. Clients will typically have 40 to 60 holdings. Danny Cox, head of financial practitioners, says this helps reduce costs and tax liabilities. This runs alongside Hargreaves Lansdown’s full financial planning service.

At the other end of the scale is the sort of service offered by Rensburg Sheppards. David Bulteel, executive director at the group, says, ‘Our products are tailored to the client. If a client works in the banking sector and their livelihood is therefore tied into this area, we would take that into account in the portfolio with a lower weighting to banks. Or if a client is heavily invested in buy-to-let property, we would take care to adjust his portfolio accordingly.’

However, most discretionary management services have much in common. For example, they all undertake a risk-modelling exercise for each client. For many, this will be part of a wider financial planning process. At the Route Group, the financial adviser builds the risk profile with the client and passes the appropriate asset allocation to fund management group Thesis, who then manage the portfolio. Mark Worrell, managing director of the Route Group, believes this customised risk profile plus greater control are key selling points for handing assets to a discretionary manager.

Setting the goals
Most will look at the client’s time horizon, financial needs (such as school fees) and general attitude to risk. Fred Robinson, director of the managed portfolio service at Killik & Co, says, ‘I always ask a client whether, if we had a review in six months and the portfolio had dropped 20 per cent, could they sleep at night? We make sure our asset allocation reflects that.’

Many groups will offer a bespoke portfolio of collective funds for less than £100,000. Most portfolios end up being a blend of equities, bonds and alternative investments, such as hedge funds, private equity or commodities. Worrell says clients increasingly want alternative funds.

Rensburg Sheppards invests directly in equities for areas such as the UK, and uses collectives for strategic asset allocation or markets in which it does not have much expertise. Bulteel says that collective funds are used for an exposure to, say, India. Most have in-house teams providing information and ideas to fund managers, but some, like Rathbone, rely on outside analysts, believing the real skill is in sorting, not generating, information.

Jane Sydenham, investment director at Rathbone, says, ‘Some clients want us to manage only their UK equity mandate, while others will want a full asset allocation service. The average is a mix of individual equities and managed funds.’

Most use a team approach for the research, but the fund managers have the final say over the portfolios and manage client relationships. In an era of call centres and absent bank managers, discretionary fund managers provide a person who investors can get hold of at any time. Bulteel says, ‘When markets are tough, clients like to be able to ring someone up and say “should I be worried?” Having that type of relationship is vital in discretionary management.’

Discretionary management has become more popular over the past ten years as financial markets have become more complicated. John Norbury, chairman of private clients at Tilney, says ‘The origins of discretionary management are in equity stockbroking. But the offering has materially evolved from simply a discussion about whether or not a client should buy BP to a total asset management service covering all asset classes.’

Bulteel says he has seen a swing to discretionary rather than advisory managed services: ‘Markets are more global and more sophisticated. They are also more correlated. This has created a need to pass over day-to-day decision-making to a specialist.’

How much will it cost?
Norbury says the usual discretionary client is more characterised by his mindset than wallet size. He will not have the time or inclination to budget. Hargreaves Lansdown has a three per cent initial charge on the first £150,000, two per cent on the next £250,000 and one per cent above £400,000. Annual management fees are 0.475 per cent plus VAT.

Rensburg Sheppards charges an annual management fee of one per cent plus VAT up to £500,000 and a sliding fee scale downwards thereafter. Killik & Co charges one per cent plus VAT on the first £250,000, then a sliding fee scale.

This does not include all costs. Unlike unit trusts and OEICs, discretionary managers are not obliged to quote a total expense ratio (TER), though many outline these costs separately. Ongoing costs are competitive with fund of funds, which usually report a TER in the region of between 1.5 and two per cent per year.

Most compare performance against benchmarks, but Killik’s Robinson admits the industry could do better. ‘Part of a portfolio may be matched to one benchmark and we do need to get more sophisticated at this. As most of our portfolios are long term,
we tend to focus on an equity benchmark and we tend to use the All-Share. We used to use the APCIMS (Association of Private Client Investment Managers and Stockbrokers) indices, but we found they took a geographic view, whereas we look across regions. In each situation we will develop a bespoke approach.’

Comparative data is hard to find. Sydenam says that it is easier to judge performance for groups with retail funds in the market alongside their private client business. There is always the risk of a dud fund manager, but most discretionary managers have strong internal controls. Tilney, for example, holds all its performance figures centrally. Norbury adds that ‘Individual managers have
to enter the objectives of the client so we can see if they are breaking the guidelines.’

A personal service
Fund managers are also relationship managers, so each has to look you in the eye when reporting underperformance. However, this has not stopped some very poor performance, and investors should ensure that they get the returns they expected.
If a manager promises to preserve capital, they should do so, no matter what is happening in the financial markets.

Unlike in a fund of funds unit trust or OEIC, transactions made by a discretionary manager are subject to capital gains. Portfolio sizes have risen over the past few years, Killik reporting an average size of £500,000. At those levels, it does not take much turnover to reach the CGT annual limit of £9,200 (for 2007/08).

Discretionary management becomes more cost effective with larger portfolios. Many believe any extra costs or tax disadvantages are a price worth paying for a bespoke service with a fund manager on call and to avoid the hassle of monitoring their investments. Some will undoubtedly get better and more appropriate investment performance than they would from traditional collective funds. With comparative performance data hard to come by, it is important that you monitor performance to ensure that it is in line with expectations.