How to manage client risk

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. 

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."

The adviser needs to make sure that the mandate at outset aligns to the needs of the client.Mike Morrow, Parmenion

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. 

“Building properly diversified portfolios is paramount and having the risk systems and expertise is an essential part of any MPS solution."

The right relationship

The DFM should be crystal clear on what the portfolio is setting out to achieve, while the adviser needs to make sure their clients are in the right mandate on a continual basis.

The relationship can also be different between the DFM/adviser/client depending on the contractual model – reliance on others or agent as client. 

Morrow says: “Ultimately, in both models, the adviser holds the primary relationship with the client, and an important part of the relationship is establishing the roles and responsibilities up front.  

“The DFM can support the adviser through volatile markets, so initial due diligence and partnering with the right DFM culturally is an important step.”

Craig Wright, managing director at Evelyn Partners, adds: “The portfolios will have a mandate and the mandate will have a tolerance to risk. This might be probability of loss, guideline equity weights, restrictions on credit ratings etc. They also should include the DFMs attitude to liquidity, gearing in the funds used, use of investment trusts, that type of thing. 

“The DFM’s responsibility is to maintain the portfolio in the risk tolerance of the mandate and get the best possible returns for the risk taken. The adviser’s responsibilities include selecting and monitoring the DFM and putting the client in the correct risk-rated MPS and monitoring its appropriateness regularly.”

To make the adviser’s work less cumbersome, IFAs should seek out DFMs that are accessible and agile in their response to the adviser’s changing client needs.

DFMs are very conscious that the client is the IFAs client.Craig Wright, Evelyn Partners

Lewis Hamm, chief executive of O-IM, explains most DFMs will have portfolios designed for each risk profile and will measure themselves against an appropriate benchmark so the risk profile is likely the simplest one to match. 

However, income requirements then vary as they largely depend on a client’s personal situation and how best they can take income. 

For example, if the client has a large capital loss on an account but is currently drawing a taxable income, they may wish to sell assets on a regular basis to provide that income, as capital gains tax can be offset. 

Hamm adds: “An accessible DFM who is able to engage with the adviser for specific client needs and who can create bespoke solutions can greatly assist an adviser when they are trying to place a solution.”

Another consideration is ensuring that the DFM an adviser uses does not negatively impact the relationship with their client.

Wright says: “DFMs are very conscious that the client is the IFAs client. In MPS on platforms the DFM operates typically under the agent as client process, meaning the adviser is acting as agent of the client, so therefore there is absolutely no client contact with the DFM. 

“For bespoke DFM portfolios, DFMs have an obligation under the FCA rules to undertake suitability assessment (with the IFA) and reporting requirements with the client, however modern DFMs will always communicate with the IFA their preference towards access to their clients.

Ima Jackson-Obot is deputy features editor at FTAdviser