A key drawback to advisory services is that, while a manager will complete the investment transactions on your behalf, this can only be done after he or she has received your approval, either verbally or in writing. This can be a slow process as you may not be available when the manager tries to contact you and thus you may miss out on a short-term investment opportunity.

Streamlining the process

Discretionary management differs from execution-only and advisory because you hand over responsibility for the running of your portfolio to the investment manager. In practice, the manager can make buy and sell decisions without gaining your prior approval.

Discretionary management is the most suitable service if you do not feel you have sufficient time or knowledge to manage your portfolio. The manager is empowered to make investment decisions on your behalf once he or she has established your objectives, risk profile and the length of time over which you want to achieve these goals. This is known as the “investment management agreement” (IMA). It ensures that the discretionary managed portfolio is tailored to your specific requirements and that the manager has drawn up the most appropriate asset allocation.

The IMA sets out your objectives, the time frame within which you expect to meet them, your risk profile, the asset allocation, any investment preferences, constraints over the type of stocks, sectors and funds that can be included in your portfolio, currencies to be used, benchmarks against which to measure the performance of your portfolio and how ongoing reviews and reporting will be conducted.

Setting the benchmark

Choosing an appropriate benchmark is important as it helps you to evaluate whether the discretionary manager is meeting your goals within the risk profile and investment constraints agreed. The benchmark may be an existing index, such as the FTSE All-Share, or a tailored benchmark that includes all the asset classes within your portfolio, or cash.

Managers have different ways of establishing your risk profile, with many using a questionnaire. The manager may establish your risk profile by determining the largest negative returns you will tolerate over different time periods.

Traditionally, stockbrokers’ discretionary services used a mix of equities, fixed-interest and cash in portfolios. But increasingly managers have expanded their service to include alternative investments like property, hedge funds, structured products and private equity. You should check which asset classes managers use and how they rate the risk level of each of them.

A mix of assets

Typically, managers use a mixture of individual securities as well as collective funds. The way in which these are used does vary, however. Most will use single equities for the UK portion of your portfolio. For overseas equities and other asset classes, many managers will opt for collective investments.

The proportion devoted to individual securities partly depends on how much you invest. The smaller the value of your portfolio, the higher the proportion that will be invested in collective funds.

The way discretionary portfolios are managed and the type of service you are provided with can vary significantly. It is therefore difficult to generalise about discretionary management services.

Indeed, it is important that the discretionary service should be tailored to your wishes. Make sure you understand the management process, the way in which your portfolio will be run, who will be responsible for its performance and with whom you communicate. Tell the manager if you disagree with or do not understand any transactions he or she makes.

The amount and frequency of information that the manager provides will vary. Some managers will send written valuations and information about the portfolios every three months while other managers will only issue information at six-monthly intervals. For example, Jason Day, director of Allenbridge, prefers to send valuations every six months. He argues that quarterly valuations promote short-term thinking by investors.

The level of detail also differs. Some managers restrict the information to valuations and transactions conducted during the last quarter or six months. At the other extreme, you may receive detailed explanations for changes to your portfolio and the manager’s views on markets and asset classes.

Typically, your manager will sit down with you once a year to have a detailed catch up. This will involve a review of the performance of your portfolio and an evaluation of whether the asset allocation needs to be changed. You may need to rebalance the strategic weightings to asset classes because equities, for example, have grown in value more than fixed-interest and hedge funds. The asset allocation will also be altered if your objectives, time horizon or risk profile have changed over the past year.

Of course, you can talk to your manager more frequently, especially if your personal circumstances change during the year, for example if you gain a promotion or have a baby.

Which model?

There are two main models for the way in which your money is managed. With the first, the relationship manager establishes your objectives, risk profile, time horizon and investment constraints before passing the asset allocation to a central committee. This committee constructs and manages your portfolio according to your requirements. Richard Fellows, managing director of Fisher Wealth Management, describes the relationship manager as a “gatekeeper” under this model.

With the second approach, the relationship manager undertakes all of these functions, including constructing and managing your portfolio and attracting new clients to the business. Under this model, most firms supply relationship managers with research and recommended lists of stocks and funds from which they construct your portfolio. But Alun Evans, director of Rensburg Sheppards, says the final decision rests with the relationship manager.

The choice is yours

There is no one right way to manage your portfolio. The most appropriate will be determined by your personal preference. There are a number of issues to consider. If the firm has a centralised approach, check whether the portfolios are standardised and, therefore, effectively funds. Are they really managing bespoke portfolios? Are the portfolios, in reality, closet index tracking funds because the manager is wary about taking a great deal of tracking error risk?

Also, ask whether the firm puts its own products into your portfolios. If the relationship manager has not been involved in constructing the recommended list, can he or she understand the role the stocks and funds on the list play in your portfolio?

Under the more decentralised model, has the relationship manager got the expertise and time to successfully manage your portfolio and fulfil his or her other roles? Can one person be knowledgeable about all asset classes and stock markets? Does the performance depend on which relationship manager you are given? How much discretion does the relationship manager have over the choice of stocks and funds, and how long is the recommended list?

How much will it cost?

The minimum amount you need to use discretionary management services and the charges you face also vary. Brewin Dolphin, for example, says it has no minimum investment. For small amounts of capital, however, Brewin Dolphin is likely to use funds. At the other end of the scale, GAM requires

£1 million for its discretionary service. The minimum investment for most firms ranges from £100,000 to £500,000.

There has been a move among discretionary asset managers to levy a flat fee, often one per cent, on the assets within your portfolio. The fee usually falls as the size of the portfolio grows. Therefore, it has been estimated that the average annual fee across the industry is 0.8 per cent.

Check whether the manager also charges a commission on buying and selling investments. Some managers offer a choice of charging structures, with a higher annual fee being combined with lower commission charges and vice versa. Commission charges may be as high as 1.5 per cent of the value of each transaction.

A discretionary service enables you to hand over the running of your portfolio to a stockbroker or private asset manager. The way in which the portfolio is managed can vary significantly, however. Talk to a number of managers before finally choosing one – you need to trust the manager to run the portfolio in your best interests.

This article is from the August 2007 issue of What Investment.