Managing your investments: Is it better to go via the ‘Advisory’ route or the ‘Discretionary’ one?

Dubai: A Discretionary Fund Manager or ‘DFM’ is someone who exercises their discretion to buy and sell investments on your behalf.

This is in comparison to an Advisory Fund Manager or ‘AFM’, one whose services allow you to consult with the money manager before he or she makes changes to your investment portfolios.

When it comes to a discretionary fund, the decisions are usually made by a portfolio manager who has the ultimate end-decision for which individual securities to hold in a portfolio.

Highly-tailored to your needs

A discretionary fund is viewed as a traditional way of managing investments, generally with an individual investment manager responsible for your investment decisions.

Essentially, a discretionary money management service can deliver highly tailored investment portfolios based upon your individual circumstances, goals and appetite for risks.

This, as mentioned earlier, is in contrast to an advisory mandate in which you, as the client, are asked to approve recommendations in advance.

High level of trust is needed

As discretionary investment managers invest your money at their discretion, there is a high level of trust and ethical considerations that must be considered in such a type of investment management style.

Moreover, discretionary investment managers need to answer to their clients if they underperform since they will be charging a fee to clients for their services.

Advisory vs. Discretionary: Risks, Perks

While some experts suggest taking the ‘advisory’ route, it is found that the key positive factor is that this method is highly client-engaging, meaning they are much more interactive with their respective investors.

While this fosters a comparatively better relationship between the end user and the manager, this is often seen as an option with lower business-related risk as each adjustment to the portfolio is done with the client’s approval i.e. your nod.

The downsides of a money manager that provides advisory services is twofold. The risk for the adviser, and possibly also you as the client, is that it requires the adviser to frequently establish contact with you to approve the adjustments made to your portfolio.

This may lead to challenges if you as the client is not in the same time zone as the adviser, or may not be contactable, or just doesn’t want to think about any portfolio adjustments at any given time.

When it comes to discretionary investing, the clear benefits are that the adviser or portfolio manager can take advantage of short-term market opportunities, turning quick profits as and when the manager sees fit.

A discretionary investment manager perhaps can get an added advantage of handling many portfolios at the same time, and reduce or eliminate the workflows for frequent client communications or confirmations when adjusting portfolios.

One downside is that in many countries the regulatory overheads and approvals to offer a discretionary service to investors is sometimes quite challenging in terms of license approvals, education and experience requirements and often firm capital adequacy requirements.

Advisory or Discretionary: Which is better?

Non-discretionary or advisory investment managers are characterised by conducting all the research and recommendations of the investment process. However, you retain the right to make the end investment decision as the client.

It is effective since the investment managers do not need to bear the risk of making the wrong decision, and you retain responsibility for decisions that are made while still receiving professional research and advice.

However, the caveat is that the decisions may be made a lot slower, and not in an efficient manner if the end decision is left to you as the client.

Therefore, discretionary investment management can be more effective in executing investment strategies in a timely manner since you do not need to be consulted before making an investment decision.

However, keep in mind that discretionary investment managers lack complete free rein over your investment decisions. The managers must make decisions according to the clients’ wishes, which are usually outlined in an Investment Policy Statement (IPS).

Key takeaways

• Advisory management services allow you to retain full control over your portfolios and make your own investment decisions. The investment advisor's role is primarily to offer an informed opinion.

• While a wealth manager who offers advisory services consults with you as their clients and provides advice, it's you who make the ultimate buy-and-sell decisions. In advisory management, it's the client who makes the ultimate buy-and-sell decisions.

• Discretionary investment management works in the opposite way. In this discipline, the professional wealth manager takes more control of investment decisions.

• For you as the client, the discretionary approach is more hands-off, and is suitable if you may not have the experience or time to actively manage your own portfolios.

• Discretionary investment management can only be provided by highly experienced professionals, many of whom have the Chartered Financial Analyst (CFA) designation.

While advisory managers always spend time understanding your goals and assets, this is often not as thorough a process as with discretionary managers.

This gives discretionary managers a theoretical edge over its rival. However, there are three key risks involved in using a discretionary investment manager, which are as follows:

1. Discretionary investment managers charge a fee for their services, and it takes a portion out of the end return that a client receives.

2. Due to the unpredictability of financial markets, there is a definite possibility that the investment manager will actually underperform their benchmark.

3. Discretionary investments require an utmost confidence in the investment manager to make the best investment decision. However, many clients may become fearful when they begin losing money and want to pull their capital out from the discretionary investment manager, which limits the manager’s ability to execute on their strategies.

So if you are opting to choose a discretionary investment manager, be mindful of the above risks.