Set the boundaries

The Retail Distribution Review (RDR) brought in a number of changes to the wealth management industry. It also clarified the roles between the financial adviser (adviser), the discretionary fund manager (DFM) and the client. Suitability, and who takes responsibility for what part of the advice and investment management for the client, continues to be a dominant theme within the industry and was specifically brought to light by the then Financial Services Authority’s (FSA) ‘Dear CEO’ letter in 2011.

The financial regulator isn’t concerned about which party is responsible for suitability, rather that responsibility is explicitly taken for suitability and it is conducted thoroughly. So who takes what role in client relationship to assist them in reaching their investment objectives?

The then Financial Services Authority’s 2011 review of wealth management firms highlighted that for suitability to be demonstrated sufficiently, the adviser and/or DFM must gather a wide range of ‘know your client’ information, including a client’s financial situation. Of equal importance is ensuring that the portfolio is suitably constructed using this information, i.e. a creating a portfolio that accurately reflects the client’s attitude to risk and investment mandate.

Advisers and DFMs can work together to ensure that the DFM investment process at a micro-level is consistent with the adviser’s holistic approach. This should mean that both adviser and DFM can fulfil their obligations to the client while being comfortable that each party’s specialised skills are being used efficiently.

In our view, when an adviser takes on the responsibility of suitability, the client understands that the adviser:

• determines the knowledge and experience of the client to assess whether the client understands the risks involved in having an investment portfolio; and

• obtains information about the client’s financial situation to determine whether they can bear any potential financial loss related to their given risk profile and proposed portfolio.

In this instance, the DFM’s responsibility for suitability consists of creating and managing an investment portfolio in line with the risk profile and investment objectives established by the adviser and the client. It is important, therefore, that the adviser has a strong knowledge of risk-mapping to ensure that their recommendation, for example a medium-risk mandate, matches the needs of the client given the DFM’s definition of medium risk.

This task is arguably made harder for the adviser as each DFM has a different definition of risk, and the risk profiles and asset allocations produced from this are likely to vary.

How does a DFM meet their requirements of suitability for the client? By ensuring that each investment vehicle and holding used to construct the portfolio meets the investment objective and risk profile of the client when viewed in aggregate.

Looking at these aspects is only the beginning. It is by combining different asset classes, reviewing their volatility and other characteristics, and examining the portfolio as a whole that you can ensure the portfolio meets the risk profile’s definition. The DFM’s role is to ensure the portfolio fits the investment objectives with an acceptable amount of volatility, and that this continues.

The DFM must demonstrate that appropriate controls and procedures are in place to consistently monitor portfolio analytics. To be comfortable that the appropriate level of due diligence has been completed and to ensure that suitability has been met, we completed more than 20,000 hours of research last year, undertaking challenging phases of analysis before any investment is considered for a portfolio.

Clearly defining the adviser’s extensive role – together with the management of the investment portfolio provided by a DFM – should create a much stronger foundation for the client, who is benefiting from extensive knowledge, experience and time to complete all aspects of their wealth management.

Claire Bennison is regional director at Brooks Macdonald in Manchester

She writes a regular in-practice article on asset management for Private Client Adviser

This article was published in the September 2013 issue