What a DFM should deliver

The key word to note here is ‘discretionary,’ which Guy Stephens, managing director of Rowan Dartington Signature, points out means the investor agrees an investment mandate based on a defined level of risk and an objective, which is usually one of growth, income, or growth and income (Balanced).

For advisers, he says it is vital when deciding to use a DFM that they make sure the investor understands the risk parameters he is agreeing to in the discretionary mandate.

Mr Stephens says: “There is no such thing as ‘low-risk equity exposure’ – all equity risk is at least of risk level five on a scale of one to 10 and the investor should be familiar and comfortable with the volatility characteristics of equities and the proportions within his portfolio relative to other asset classes such as cash and gilts.

“It is this very factor that has been the subject of close scrutiny by the FCA where there is a mismatch between the understanding and awareness of risk between the adviser and client.”

He says that using a “mechanistic risk profiler” is only part of the process and this should not be relied upon in isolation nor over-engineered.

“The important point is to stress the long-term benefits of equity investment but make the client aware that equity markets have halved and doubled twice in the past 10 years”, Mr Stephens added, “so that an appreciation of what can happen is embedded in the advising process and fully documented in case of future disappointment and potential complaint.”

There is no such thing as ‘low-risk equity exposure’ – all equity risk is at least of risk level five on a scale of one to 10 Guy Stephens

In terms of the advantages of this approach, Mr Stephens says having a discretionary mandate means the appointed DFM can take advantage of market opportunities as they arise without having to refer to the adviser and/or client beforehand.

In fact, Mr Stephens says the advantages go further than that, because the normal advisory process between the adviser and client involves an annual review and decisions are made at that point and only at that point and will require signatures, documentation and processing lead-times.

When appointing a DFM, Mr Stephens says the adviser and client is replacing a one-hour yearly review meeting process with a 24/7, 365 days a year process where decisions can be implemented immediately, electronically and without any documentation requirement.

He says this enables the investment decision to be prioritised and acted upon, whereas under an advisory relationship, it may take a week or more to action the decision by the time the client has been contacted, paperwork signed and instructions delivered.

Of course, Mr Stephens says it should not be forgotten that any DFM is just as capable of buying a poor investment as any financial adviser.

But the theory is with their 24/7 specialised focus and expertise, a DFM should be able to add value over and above their fee, and should deliver superior performance compared with the alternative services the adviser would be able to provide.