The DFM dilemma: Is agent as client putting the risk on advisers?

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The ‘agent as client’ model, where an adviser establishes themselves as the client of the discretionary fund manager is the most common arrangement for outsourcing client assets to a DFM. With AAC there is no direct contact between the DFM and the end investor, thus minimising the risk of client poaching while allowing the adviser to remain at the forefront of the whole arrangement. The model also has a clear benefit to the DFM; by not knowing who the client is, the financial planner assumes all responsibility for suitability.

The AAC model is widely used across the industry. At NextWealth we recently did a deep dive look at discretionary managed model portfolio propositions. Among the 17 DFM’s covered in our research, 12 operate using  the AAC model. The most common alternative model, ‘reliance on others’, is used by Rathbones, PortfolioMetrix and Fairstone.

Reliance on others is similar to AAC, with the main operating difference being that both the financial planner and DFM have a legal and regulatory duty of care to the same client. The AAC format suits DFMs as they gain the assets but do not have to bear responsibility should anything go wrong from the end clients’ perspective.

Potential risks for financial planners under the AAC model

Some financial planners mistakenly assume because they are registered with the FCA they have the authority to appoint DFMs on the behalf of their clients. However, this is not the case, and standard advisory agreements do not extend to this level of authority, leaving many advisers who act beyond this open to potential risks.

If the agent, in this case the adviser, has acted outside their level of authority then both the client and the counter-party – the DFM – may each have a case against them. The very real risk of advisers misunderstanding these agreements recently led the Personal Finance Society to produce a white paper on the issue, calling for greater transparency and a clearer understanding of what the terms and conditions in an arrangement actually sanction the adviser to do. 

A complication that can stem from an AAC arrangement is that the financial planner may be classified as a ‘per se professional client’ in the eyes of the DFM, due to their greater experience and investment knowledge. In these cases, the DFM may invest the advisory firm’s assets into products and strategies better suited for professional clients, when in actual fact the money being invested is on behalf of retail investors. This creates a potential mismatch between the investment and the risk appetite of the underlying investor, resulting in a breach of the financial planner’s duty of care towards the client. Furthermore, since this is all happening via an AAC arrangement, the end investor could lose retail regulatory protections and access to the Financial Ombudsman Service.

Under the AAC model there is also scope for complications in how the 10 per cent rule of Mifid II is enacted. This rule requires the end investor to be notified of a 10 per cent fall in the value of their portfolio by the end of the day in order to avoid a regulatory breach. Under an AAC arrangement, the DFM typically notifies their client, the financial planner. It is then up to the financial planner to send the notification on to the client. We understand that in most cases, the platform is notifying the end client, suggesting that this challenge is perhaps less of an issue.

 Benefits of reliance on others

Fairstone operate using the reliance on others model. Because Fairstone is both the financial planner and the DFM, they know the full model and the basis for the way the client’s risk tolerance was assessed. The risk targeting can be hard coded into the mandate because the risk assessment and portfolio management are being done by the same firm. They see this as a core differentiator. Fairstone’s portfolios are risk targeted not risk rated. 

PortfolioMetrix similarly operate using the reliance on others regulatory framework. They say this offers their partner adviser firms an opportunity to de-risk their business, given that PortfolioMetrix take on full responsibility for the investment management.

Actions and implications for financial planners

Under the AAC model, financial planners need to be doing more to monitor their DFM’s decision-making processes and suitability for clients on an ongoing basis. In the event of a breach or complaint, the financial planner will need to justify the DFM’s decisions. 

Industry best practice has increasingly called upon financial planners to ensure AAC arrangements are clear and explicit in suitability letters when making any DFM recommendation.

Financial planners should make these clear to their professional indemnity insurance providers as well. PI policies frequently contain exclusions for certain types of products and investments that aren’t appropriate for retail investors but nevertheless have been included in portfolios due to the adviser being treated as a professional client. In these circumstances, there is a real danger that PI cover could be jeopardised. 

In most cases, the DFM will be managing to the client's stated risk profile and the platform will handle the client communication, thereby negating some of the risks raised with the AAC model. But advisers using DFMs on an AAC model should be following best practice to explicitly inform clients of the arrangement and inform their PI providers.

Heather Hopkins is managing director at Next Wealth 

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