By Ashveena Teeluckdharry-Khusial
Typically, asset owners or stewards such as financial advisers, retirement fund board of trustees and insurance company balance sheet investment committees in need of investment solutions delegate investment function/s to a or multiple third parties. Sub-delegation refers to the practice of an investment manager delegating a sub-set of clearly defined responsibilities to another party without transferring the ultimate accountability for the overall investment solution and/or function.
Practised in particular by multi-managers, sub-delegation is also used by single managers and financial advisers to improve investment outcomes. (A multi-manager is an investment manager that creates solutions for investors across asset classes, by combining various styles and strategies from a range of investment managers.)
Single managers often sub-delegate investment administration functions such as independent pricing and the use of pooled funds, whereas financial advisers may sub-delegate functions such as building an investment strategy and portfolio construction, and manager selection.
These financial advisers typically sub-delegate to discretionary fund managers (DFMs) – investment experts who are given the discretion to make investment decisions and to create solutions suitable for financial advisers’ clients. This practice has been common among United Kingdom-based advisers for some time now (to the extent it is specifically legislated), and it is increasingly becoming a feature of the investment landscape in South Africa.
So, why do these various industry players sub-delegate? Typically, advisers or fund managers may be looking to leverage specialised expertise in particular asset classes, maintain focus on core functions, manage complexity and/or optimise resources (by delegating non-core functions that are resource-intensive or that require investment in expensive systems). In the case of multi-managers, diversifying across investment capabilities through sub-delegation helps mitigate investment and operational risks for investors by reducing their dependency on the decisions of a single individual or team.
Sub-delegation does not come without risk and must be carefully considered before being adopted. The responsibility for investment advice and outcomes is not transferred through sub-delegation; hence, anything that goes wrong in the process will adversely affect the reputation and business of the sub-delegating party.
In the ultra-competitive investment space, reputation is arguably the most significant differentiator – which is why everything possible should be done to minimise such risks. In addition, sub-delegation does bring with it financial risks (e.g. the costs of unwinding a poorly structured agreement), operational risks (e.g. failure to meet service obligations), regulatory risks (e.g. losing an investment license because of some material legislative contravention) and legal risks (e.g. being sued for breach of contract). These must all be regularly monitored and mitigated wherever possible.
Ultimately, though, the key to mitigating these risks, and successfully using sub-delegation, lies in the strength and sustainability of the relationship and long-term mutual value creation between the partners involved in the process. Selecting the right partner based on their integrity and trustworthiness is, therefore, critical.
Here are five-pillar rating process to evaluate and select managers, and this objective framework reduces subjectivity in sub-delegation decisions. Financial advisers and retirement fund boards of trustees can use a similar approach to assess DFMs and investment consultants.
On a high level, these five pillars cover the following:
Business sustainability
Who owns the business? How would you rate the business from a corporate governance perspective (i.e. overall management structure, the functioning of the board of directors, and the company's commitment to maintaining high standards of corporate governance)? What is the size of the business – has it achieved critical mass in terms of assets under management and/or advice? Is it scalable and/or sustainably profitable? How vulnerable is the client base (to changes in economic circumstances, poaching from competitors, cyber threats, etc.)? How well-developed is the business’ disaster recovery plan? What backup systems and processes does it use? How does it store and protect data?
Key people
Who are the key decision-makers running the business? What is the depth and breadth of the team in terms of qualifications and experience? What succession planning is in place for these key decision-makers? What affiliations do they have, and what reputational risks do these affiliations carry?
Compatibility, alignment and transparency
What is the company’s business culture, and how compatible is it with the sub-delegating party’s culture (do you share broadly similar values and views around diversity, inclusion and transformation, for example)? What is the business’ investment philosophy, and is it aligned with yours? For example, a financial advisor assessing a DFM might evaluate how a DFM goes about setting and achieving investment objectives, and whether this is the right approach for the adviser’s client base. Another important consideration is transparency. Are the contracts, fee structures and financial statements transparent and unambiguous? In the realm of investment, transparency is not just a virtue; it's a cornerstone for trust and informed decision-making.
Performance
Does the business have a track record in providing those sub-delegated services? How does that track record compare with those of its competitors? Has the business provided client references or testimonials? Is it necessary to perform a survey of existing clients to test the quality of its service delivery?
Resources/services
To what extent is the business tech-enabled and its processes automated, and how does that improve the sub-delegating party’s offering to its clients? What are the standard reporting processes (frequency, manner, platform)? What technical marketing support is offered (if any)? How much does the DFM invest in technology and systems (this can determine future scalability, cost management and innovation)? Is the business committed to continual improvement and enhancement of the services it provides?
While fees and fee structures are clearly important when considering sub-delegation, they should not take precedence over any of these five points. Cheaper does not always imply better, and prices (fees) must be considered in relation to the value provided. Once you are comfortable that there is a reasonable relationship between price and value, it’s also important to understand the way fees are structured (is there some form of sliding scale, i.e. do unit costs decrease with increasing volume?), annual escalations and when fees are payable.
Of course, merely selecting the right partner does not guarantee success when it comes to sub-delegation. Monitoring and constant evaluation are crucial – it’s important to have aligned KPIs, a clear agreement on service levels, regular benchmarking and strong feedback loops to draw attention to potential red flags and allow for their swift resolution. Agreements should be carefully constructed to allow for the clean and rapid termination of relationships in worst-case scenarios (drawn-out separations can be financially and reputationally damaging). Finally, appropriate risk management practices and backup plans must be in place because accountability still sits with the delegating party.
The art and science of successful investment sub-delegation starts with clearly defined, measurable and intentional outcomes. Done correctly, sub-delegation can benefit all players in the value chain. For financial advisers, the right partnerships, underpinned by robust and repeatable processes and strong governance, will enhance the value of an advisory business.
* Teeluckdharry-Khusial is the chief investment officer at Hollard Insurance.
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