Identifying client’s attitude to risk is vital to the process

This can include a questionnaire assessing attitude to risk and an assessment of the client’s capacity for loss. This is also likely to be validated through conversations with the client combined with an assessment of their financial position and investment requirements.

The process culminates in the client and adviser agreeing on the level of risk the client is prepared to take within an investment portfolio.

Once this is agreed, in-house portfolios, risk-rated multi-asset funds, use of model portfolios on platform and outsourcing of the investment mandate to a discretionary fund manager (DFM) are all potential investment solutions open to the adviser.

The DFM option of an individual discretionary portfolio is often used where there exist portfolios or holdings that may have substantial capital gains attached or where the client wishes to impose particular stock or sector restrictions.

Whichever outsourcing option is used, the adviser will wish to ensure that the investment portfolio put in place by the outsourced provider corresponds to a stated risk level agreed between the client and adviser.

For options such as multi-asset funds or externally managed model portfolios on platforms, there are ready-made solutions in risk-rated funds or risk-rated model portfolios.

However, by their nature, individual discretionary portfolios that may contain specific individual holdings at the request of the client, or that may be managed to take account of unrealised capital gains positions, do not lend themselves to more standardised solutions.

To ensure a tight link between the outcome of the adviser discussion with the client and the risk level to which the portfolio is managed, it is important there is a common language and clear understanding at the outset of how the discretionary investment manager will manage the portfolio.

Equally important is an understanding of how the risk will be managed, aligned to the risk level and monitored on an on-going basis.

As individual discretionary portfolios will not be identical and will be managed actively on a day-to-day basis, it is vital that the investment manager has a robust process for calculating the risk of each individual portfolio regularly, and compliance oversight within the company to ensure that each client portfolio is being managed to its specified risk level.

The inclusion (or exclusion) of specific holdings at the request of the investor will inevitably produce a portfolio that may diverge from the discretionary investment manager’s ‘model’ portfolio.

The flexibility provided by individual discretionary portfolios and the opportunity they provide to optimise the investor’s tax position, accommodate a client’s specific preferences or gradually manage down capital gains positions, is compelling.

However, it is vital that this is undertaken in a way that ensures continued alignment with the client’s accepted risk level.

A clear understanding of how this can be achieved at the outset and then monitored should be an important part of the adviser’s due diligence review of the discretionary manager selected.

Marcus Brooks is director at Cornelian Asset Managers

REGULATOR’S VIEW

The FCA has published guidance on assessing suitability and establishing the risk a customer is willing to take. Firms should ensure:

• They have a robust process for assessing the risk a customer is willing and able to take, including assessing a customer’s capacity for loss and identifying customers that are best suited to placing their money in cash deposits because they are unwilling or unable to accept the risk or loss of capital;

• Tools, where used, are fit for purpose and any limitations recognised and mitigated;

• Any questions and answers that are used to establish the risk a customer is willing and able to take, and descriptions used to check this, are fair, clear and not misleading;

• They have a robust and flexible process for ensuring investment selections are suitable given all aspects of a customer’s investment objectives and their financial situation – including the risk they are willing and able to take – as well as their knowledge and experience;

• They understand the nature and risks of products or assets selected for customers;

• They engage customers in a suitability assessment process (including risk-profiling) which acts in the best interests of those customers.