Discretionary Investment Management Services (DIMS) providers need to up their game on strategic asset allocation and risk controls, according to the inaugural regulatory probe into the somewhat opaque market.
The Financial Markets Authority (FMA) debut public report on the sector found almost a quarter of the 49 DIMS providers had not reviewed portfolio strategic asset allocation (SAA) settings over the previous 12 months.
DIMS operators need to review SAAs on “a regular basis and consider any appropriate changes”, the regulator suggests.
At the same time 13 per cent of DIMS firms – a diverse population spanning small advisory firms to large broker-based entities and banks – retained the ability to invest client money across any asset class in a 0 to 100 per cent range.
“While such wide discretion is permitted, there is a risk that managers may abuse this and seek to time their investment in markets, rather than adhere to a long-term allocation strategy,” the FMA report says.
“… It is unclear whether 0-100% ‘limits’ are in the investors’ best interests or are designed to reduce the burden of compliance obligations, as portfolios with no asset allocation limits are easier to monitor.”
Overall, the more than $48 billion licensed DIMS market held about a third of total assets in global equities followed by NZ fixed income securities ($10.8 billion or 22 per cent) and Australasian shares ($9.7 billion).
Compared to even the KiwiSaver sector, DIMS portfolios appear to be more tilted to local assets.
For example, NZ fixed interest and cash represent almost 30 per cent of DIMS money versus 23.8 per cent of the KiwiSaver assets under management as at the end of June this year (based on Morningstar data). KiwiSaver investors hold 17.2 per cent in global bonds and almost 40 per cent in international shares compared to 13 per cent and 33 per cent, respectively, in DIMS-land.
The FMA survey found the actual level of individually tailored investments in DIMS portfolios may be lower than providers disclose with clients instead bundled into standardised models.
Almost 40 per cent of DIMS firms promote their services as bespoke to each client but some of those investment strategies were more vanilla than expected, the report says.
“Investors were given generic labels such as growth, balanced, conservative etc, and deviations to the investment strategy based on investor objectives and risk preferences were often minor.”
Despite the prevalence of model portfolios comparable to managed fund asset allocations, DIMS investment performance is not subject to public reporting. (And more than a third of DIMS providers exclusively use underlying managed funds to invest, the regulator found.)
John Horner, FMA markets, investors and reporting director, said the sector probe “did not consider DIMS portfolio returns, as portfolios vary significantly”.
“However, we did consider whether benchmarks were applied as a measure of portfolio performance,” Horner said.
He said the regulator also didn’t attempt to measure total management expense ratios across the DIMS market.
But Horner said the FMA “would like to understand more about how DIMS providers are disclosing fees to investors, and this will include consideration of any turnover expenses that might apply”.
According to the report, nine of the 49 DIMS providers account for 81 per cent of total funds under management in the sector while 15 firms manage under $100 million each (collectively amounting to 2 per cent of the overall market).
DIMS came into focus following the collapse of Ross Asset Management (RAM) in 2012 that revealed holes in the investment licensing regime. Post RAM, the government introduced tighter reporting and custody requirements for DIMS providers while also introducing two licensing approaches – ‘personalised’ and ‘class’ DIMS, equating to individually tailored and standard model portfolios, respectively.
While the licensing distinction between personalised and class was removed in 2021, “these terms are still recognised and applied by many DIMS providers as a useful way to distinguish between the two broad service offerings”, the FMA report says.
As part of the sector survey, the regulator engaged closely with nine DIMS firms that resulted in separate feedback to each provider laying out “any potential issues and recommendations”, Horner said.