Different types of discretionary accounts and fee models
Depending on the business model and the specific agreement entered into with the client, discretionary account managers are entitled to different levels of discretion authority, allowing them to trade in investment products on behalf of their clients without having to obtain specific authorization from clients. Discretionary accounts can be broadly classified into two categories:
1. Discretionary account management services provided as an ancillary part of brokerage services without setting up an investment mandate
Some brokerage firms provide discretionary account management services as an ancillary part of the brokerage services for the clients. This type of discretionary account service usually covers only exchange traded products. Therefore, no investment mandate will be set up with the client, e.g. when a client opens an account with the brokerage firm, the client authorizes the brokerage firm to operate his/her account to conduct trading. The discretionary account manager would usually only receive brokerage commission for trading listed securities and other fees related to securities trading, e.g. custody fees.
Brokerage firms offering this kind of discretionary account service are generally required to obtain the relevant licence from the Securities and Futures Commission (SFC), and comply with the SFC's requirements relating to discretionary accounts, including the relevant section on discretionary account authorization and operation under the "Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission". For example, discretionary account openings should be approved by the brokerage's senior management, who must make sure there are adequate internal control procedures for proper supervision of the accounts.
2. Discretionary accounts with an investment mandate or a predefined model investment portfolio
Another type of discretionary account involves managing the client's portfolio in accordance with a mandate or a predefined model investment portfolio established or chosen by the client. Generally, this type of service covers a wider range of investment products, including both exchange traded and non-exchange traded investment products.
Discretionary account managers (e.g. brokerage firms, investment management companies or banks) normally discuss the investment objectives, risk appetite and personal circumstances with the client before deciding the types, risks and allocation of investments as part of the mandate of the discretionary account. Alternatively, the discretionary account managers may use different investment products to build various predefined model investment portfolios, listing out the proportion of the asset classes and markets, as well as the risk profile of each portfolio. For example, the investment portfolios can be categorised as high, medium and low risk, for selection by the client.
This type of discretionary account service is usually subject to management fees and performance fees based on the total value of the managed portfolio as remuneration for managing the discretionary account for the client. Other fees include custody fees, trade execution fees charged by third party brokers, fund management and performance fees (if the portfolio invests in funds).
Companies providing this kind of service should be licensed by or registered with the SFC for conducting asset management activity and must comply with the requirements set out by the SFC regarding discretionary accounts, e.g. the "Fund Manager Code of Conduct".
A wrap account is an account where all the fees and charges are “wrapped” into a single or fixed fee. As such, there are no other charges, such as trading commissions for switching transactions and or other administration fees.
The client pays a fee which is a percentage of the total asset value of the discretionary account. The higher the account value, the higher the fee for the discretionary account manager. This fee model aligns the interests of the client and those of the discretionary account manager, which can prevent account churning to earn more commission.
However, this does not mean that a wrap account is suitable for everyone. For example, if the client only intends to buy and hold shares for dividend yields as part of a long-term investment strategy and does not require frequent switches of the portfolio, then a wrap account based on such fee arrangement may not be suitable.
14 November 2018