Custom Portfolios for advisers: what are the benefits and risks of co-manufacturing?

What is co-manufacturing, what are custom or tailored model portfolio and what are the risks and benefits?

What is co-manufacturing?

The growth in MPS is expected to continue

Managed Portfolio Services (MPS) have seen rapid growth, becoming a go-to investment solution for financial advisers. This has not necessarily been about performance.  The attraction is the operational efficiency it creates for advisers and therefore the time it saves them.
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For a financial adviser firm, success is a constant balancing act between growing business value and managing business risk. On the value side are activities like strengthening client relationships and finding new clients.

On the risk side is the administrative avalanche that comes with scale.  Imagine an adviser firm with a thousand clients who decides to add a new fund. Doing this the traditional way means a thousand switch letters, a thousand follow-ups and a thousand manual updates—an operational nightmare that takes time and invites inadvertent errors. Adopting a MPS solution means that fund selection and fund changes is outsourced. By offloading this operational risk, advisers free up invaluable time to focus on activities that actually grow their business value.

The value proposition for financial advice is shifting.  Historically some advisers saw their value as being in fund selection.  The more recent philosophy is to focus on holistic financial planning for a client and their family – the investment solution is a part of this but not all of it.  The key capabilities most valued by clients (and with the most impact on their overall outcomes) is robust financial planning.  Not just the asset allocation, but the location of assets, tax planning, optimising allowances, intergenerational planning.  Investment portfolios are just the drivers of risk-return for different parts of the broader financial plan. ​

Outsourcing or insourcing?

As the compliance, regulatory and research burdens expanded many advisers sought to move away from running their own portfolios to “outsource” to a third-party investment manager.
But with outsourcing, advisers also lost control or input into the investment strategy.  Clients were being lumped into cookie-cutter portfolios that reflected the manager’s philosophy but not necessarily the advisers.

This was suboptimal – particularly for advisers whose own portfolio ranges had fared far better than higher cost traditional DFMs: why would they outsource to someone who may have more resource, but may not have delivered demonstrably better results.
That’s when we pioneered insourcing back in 2018 as a response to MIFID II and the related Product Governance rules.

Clients were having to match the very detailed needs of their different client segments with one size fits all portfolios from mass-market providers.
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We figured that if we could create a capability where the advisers retain control of the objectives and design parameters of the portfolio, but the construction, rebalancing and implementation was done by a DFM, advisers could get the benefits of discretionary management without the loss of control.  That’s how Custom portfolios were born. (Some refer to this as Tailored or Bespoke (which we think confuses with individual bespoke so is confusing).

Co-manufacturing a Custom solution

Building a Custom solution with an adviser means both the adviser and the manager bringing different capabilities to the table,  This is known as “co-manufacturing”.  And the most important aspect of co-manufacturing is that roles and responsibilities are clearly allocated and documented.
Whilst we have been co-manufacturing Custom mandates for DFMs and Advisers since 2018, it has now become a fashionable trend with most DFMs looking at providing some kind of offering.
Co-manufacturing is a spectrum can range from very involved (for example an adviser-defined custom mandate setting the objectives, constraints and parameters) to very light touch (co-branding or whitelabel only).

How Custom is your Custom mandate really?

Unfortunately, we have seen a trends where some larger firms will offer to build Custom mandates which then after a year or so are almost identical to their standard models: the advisers had the illusion of input, but in practice has none.  We think it’s better to be clear about what something is.  Either it’s properly Custom or it’s White Label.  It shouldn’t be one thing pretending to be another.

Check your co-manufacturing contract

We also see different contractual models evolving in the co-manufacturing space.  Whilst advisers may be initially excited about having their own range of portfolio, they should pause and think are they actually giving away too much value or locking themselves in to a provider, or entering into a contract that incorporates questionable fee arrangements.  We see co-manufacturing agreements falling into the following three categories:

• The Good: An open model where the adviser retains full control. They collaborate on design but have the power to fire the investment manager for underperformance, ensuring they can always act in their clients' best interests.  If they are disappointed with the manager, they can fire them and move the mandate elsewhere.
• The Bad: Captive joint-venture (JV) models where advisers are locked in, possibly tempted by a promised share of the profits. In fact they have signed away control and a significant portion of their business's long-term value.  They are now a tied distributor of a DFM’s JV that they would struggle to buy themselves out of.  If they are disappointed with the manager, they have to grin and bear it because they are locked in.
• The Ugly: Fee-sharing arrangements.  This is where a manager simply gives the adviser a cut of their fee for using the product – a practice that goes directly against the principles of the Retail Distribution Review (RDR), which was designed to eliminate such conflicts of interest.  Now matter how it’s window dressed – don’t do it: you are both taking unreasonable and unnecessary business risk.  There are a smarter ways to think about business value.

The "Good" model mirrors the institutional pension market, where trustees have a clear fiduciary duty and undisputed power to fire an underperforming manager. This is the gold standard. The "Bad" and "Ugly" models see that power eroded to varying degrees, compromising an adviser's ability to fulfil their primary duty to their clients.

The key takeaway is that adviser’s control of their own business value chain should be key to any contractual arrangements.