On the up: rising demand for Custom MPS

What is driving the rising demand for Custom Model Portfolios?

Custom Model Portfolios Are Growing in Popularity

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By Henry Cobbe, Head of Research, Elston Consulting

​Custom MPS allows for financial advisors to involve themselves in the construction and oversight of the range of model portfolios offered to their clients. It is becoming increasingly popular for advisors and clients alike as the market develops. We look here at where this trend may have originated, what the momentum behind demand is and some of the potential downsides.

Why have custom portfolios become so popular?

​The launch of the Product Governance rules, which oblige advisors to make sure that the solutions they offer are suitable for their target market, prompted a renewed focus on custom portfolios. It became increasingly clear that one-size-fits-all portfolios offered by DFMs and multi-asset fund providers were neither flexible nor nuanced enough to cater to the variety in each advisor firm’s client group or investment thesis. The demand for custom MPS highlights that variety of philosophy.

What elements of Custom solutions can advisors have a say in?

​There are quite a few, including the number of different portfolios to offer, whether to use a static or dynamic asset allocation approach, the strategic asset allocation framework, the use of active or index-linked products, or both. Additionally (but not exhaustively), there is the question of the positioning of the fixed income portfolio, whether or not to include liquid alternatives and parameters of tolerance for OCFs.

What type of advisor might look to use Custom MPS?

There are three general drivers of take-up:

Implementation: there are already adviser firms out there with a keen grasp of their investment philosophy, a tried-and-tested investment process and a track record that outperforms many of their larger peers. Custom MPS allows them to carry on in that vein, but with more control because they are ‘insourcing’ professional assistance with the design and running of their portfolios.

Business strategy: for some advisors looking to obtain their own permissions, Custom MPS can be a useful stepping stone.
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Protection: DFMs have deep pockets for marketing and sales and often have a financial planning business of their own that competes with smaller advisor firms. Custom MPS allows those smaller outfits to offer a larger range of solutions in their own branding, thereby disintermediating their larger competitors.

How long has Custom MPS been a ‘thing’?

Elston was one of the first-movers in the Custom MPS sphere back in 2018, and we would ascribe the origins of the concept to two main drivers:

1. the consultancy work we had carried out in the DC pensions market where we saw that trustees, as fiduciary, have a custom investment mandate for their scheme members and accordingly a comprehensive governance framework.
   
2. the launch of the Product Governance Rules under MiFID II which prompted a requirement for robust governance and sensitivity to a client’s needs and aims. 

Essentially, we began to copy the framework that a pension scheme would operate within and replicate it for financial advisers.

How custom is Custom?

The genuine Custom operators in the market do a commendable job of formulating portfolios that are unique to, and shaped around the requirements of their adviser clients.

However, there are other providers that describe their service as ‘custom’ when in fact they are simply white-labelling an off-the-shelf product. They may carry out a tiny modification that enables them to purport to be selling a ‘customised’ product but this is no more than a token tweak. Alternatively, what starts out as a vaguely customised mandate may – over the course of a year or so – be reconfigured so as to bring it in line with a ready-made template.
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For the most part, advisers are switched on and able to tell the difference.

How can we distinguish between co-manufacturing and co-branding?

Co-manufacturing: this involves a customised mandate defined by the adviser and agreed in writing by both parties. The design and management of the Custom MPS solution is materially shaped by the adviser.  
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Co-branding: a white-label, off-the-shelf product or range that is branded with an adviser’s name. This is acceptable practice, but it is important to be clear on who ultimately is the manager.

Commercial conflicts

Some providers are making the case that a DFM can remunerate a financial adviser for their involvement in the development of a custom mandate.  In our view, this goes against RDR and the Consumer Duty.

There are also circumstances where rather than take direct payment for services rendered, MPS providers will agree a co-manufacturing arrangement in exchange for a shareholding in the adviser’s business.  While this could be the preferable route for both parties to get the deal done, over the longer term, it would no doubt prove hard for an adviser firm to part ways with a DFM by which it was partly owned, thereby undermining both competitiveness and independence.
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It is important for advisors pursuing a Custom mandate to ensure they stay in the charge and are not the subordinate partner to a larger DFM.

Summary

​Custom MPS is a welcome development for advisers and DFMs alike and increased competition from DFMs in this space should be seen as a good thing. However, it is important that as the practice grows and matures, it maintains its quality and integrity, and professional standards are upheld.