Discretionary Management  

How to manage client risk

This article is part of
Guide to MPS and outsourcing to a DFM

How to manage client risk

Outsourcing to a DFM means that risk profiling is usually carried out by the adviser using a third party or the DFM’s own tool, and clients are placed in a risk bucket relevant to a particular model portfolio. 

In most instances, the adviser will retain responsibility for assessing the client’s attitude to risk, managing income and the overall client suitability. 

The DFM will manage the portfolio to the agreed mandate and the adviser remains responsible for recommending the model that best fits the clients’ attitude to risk and financial planning objectives. 

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Robert Vaudry, managing director of Copia Capital, says that this is an area that is vital for advice firms to clearly document, both in their own contractual agreements with the DFM and also in their client agreements. 

Vaudry adds: “This ensures all parties understand who is responsible for what. Risk is managed within the portfolio in accordance with the mandate that the adviser will need to understand."

According to Mike Morrow, chief commercial officer at Parmenion, the adviser needs to distinguish between risk-targeted and risk-mapped solutions and make sure the mandate aligns with the client’s needs.

Risk-targeted explicitly manage to a framework. Risk-mapped means that at a point in time a portfolio has certain verified risk characteristics, which may change. 

Morrow says: “A DFM manages to a portfolio mandate which may or may not be risk or volatility targeted. It may, for example, be outcome targeted, for example  inflation of over 3 per cent. 

“This is an important area that can have a significant bearing on the outcome the client experiences, and alignment to suitability/advice.

“The adviser needs to make sure that the mandate at outset aligns to the needs of the client and consider whether any changes in the client’s needs or in the management of the portfolio mean revisiting their advice.”

Assessing the risk

The role of the DFM is to manage each portfolio in line with the associated volatility bands. 

There are many different quantitative models available for assessing the risk of each portfolio, but Tony Lawrence, senior investment manager at 7IM, says he would urge some caution over solely relying on just volatility. 

Risk comes in many forms, including liquidity, hidden leverage or goals risk, to name just a few. 

Lawrence adds: “An easy example here is open-ended property funds, which although they look great through a volatility lens, were not so attractive if you wanted your money back shortly after Brexit.

“We believe risk is more than just a volatility number, so although we will look to construct portfolios that will slot neatly into a risk-profiled solution for advisers, we spend a lot more time and effort ensuring that all the other risks are managed too, offering peace of mind for advisers and their clients that there won’t be any nasty surprises round the corner.