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DFM Model Portfolio Returns – The Proof is in the Pudding

Although past performance is not necessarily a guide to future performance, it is one of many aspects to consider when making a comparison between ‘like-for like’ portfolios. Leigh Kohler explains…
4 min read

Lack of transparency

Although past performance is not necessarily a guide to future performance, it is one of many aspects to consider when making a comparison between ‘like-for-like’ portfolios. Locally the performance numbers and history of collective investment schemes (CISs) are published monthly in their respective Minimum Disclosure Documents. Several consulting firms produce wide-ranging performance surveys for pension plans, such as the Alexforbes Manager Watch Survey.

In contrast, model portfolios are not regulated by the Collective Investment Schemes Control Act (CISCA) because they do not have a separate legal status. They are, however, controlled by the same legislation pertaining to Linked Investment Services Providers, namely the Stock Exchange Control Act and the Financial Market Control Act. A model portfolio effectively ‘wraps’ a selection of different unit trust funds (CISs) and although the underlying fund returns are fully transparent, the wrapped solution, or model portfolio return is typically not available to all advisers.

For years the local discretionary fund management (DFM) industry has been grappling with the issue of the performance of model portfolios and appropriate surveys to compare their returns. So far, little progress has been made, which begs the question as to why.

Model portfolios only…more effort required

Irrespective of whether a DFM is using a CIS or a model portfolio, the assessment of their performance should not vary based on the structure used to execute their investment strategies. Investors and advisers are still evaluating the ability of DFMs to manage their best investment views against pre-determined objectives or benchmarks.

DFMs with track records in managing CISs, are comparable to one another and as a result, should be included in an independent survey that can point to the

performance of these funds as proof of their abilities. However, DFMs that only offer model portfolios need to make a concerted effort to get their performance numbers out into the market in a fair and transparent manner. At times we cling so tightly to what we believe is ours, that we do ourselves harm. This is true of the struggle in the DFM industry – many are so convinced that their solutions/model portfolios are so unique that they dare not be compared to others.

We can learn from those who have already walked this path

Defaqto is a leading financial information, ratings and fintech business in the UK, that has been operating independently for more than 25 years. Their Diamond Ratings for example, are designed to help advisers and their clients make better informed decisions by providing an independent rating of 1 to 5 based on a detailed and well- structured scoring process. The ratings are calculated using a scoring method called Data Numerical Analysis. The process uniquely combines a quantitative assessment of both performance and numerous other data points, including manager tenure and costs.

In the US, Morningstar launched the Morningstar Rating™ – or star rating – to model portfolios in the fourth quarter of 2021. This star rating follows the same core

methodology that is used to assign ratings to managed investments in other universes such as mutual funds (i.e. unit trusts) and separate accounts.

Therefore, in order to cater for the growing local demand, and with more discretionary managers offering bespoke strategies, we need to follow the global trend. We need to make model portfolio returns more transparent to allow advisers to weigh a range of considerations in selecting DFMs on behalf of their clients.

We do not need to reinvent the wheel

Ideally, one would prefer an independent service provider to oversee the creation of an independent survey, using similar or different methodologies that are more suited to the local market. Suitable providers could perhaps include the Association for Savings and Investments South Africa, NMG Group, Citywire, the Collaborative Exchange, or any other similar organisation that does not operate a DFM.

Although participation in a survey should be voluntary, there will be a natural incentive to encourage involvement. Participating in the survey would allow you to showcase performance. Not publishing your results, however, would leave you having to explain why you are not participating in an independent review, to which some may rightfully argue that their solution is rare and not able to fit in any box.

As a final point, the real worth or quality of a DFM can only be determined or be judged on its results – transparent and assessable returns. The proof is in the pudding. Even though we are in a ‘transitory phase’ in getting model portfolio returns published, as part of the review process it is imperative for advisers to use the CIS (unit trust) returns of DFM providers that have a long and established track record.

Key points in this article:

  • There is currently no lawful requirement to disclose model portfolio returns. This lack of transparency is a source of frustration for the local DFM market
  • Perhaps it is time to usher in a new era of transparency with a view to unleashing the growth of the sector
  • Whist we can learn from the global trend of allocating ratings to model portfolios, the push will need to come from the local industry