DFMs and financial planners: managing objectives

If a client is using a financial planner and a discretionary fund manager, who is ultimately responsible for meeting their objectives? 
by Sandra Paul


There used to be a clear understanding of the different roles and functions of financial planners and discretionary fund managers (DFMs).

Financial planners, at the centre of the advice process, guide and support clients using tools such as cashflow modelling and specialists, as necessary, to help their clients achieve their financial and lifestyle objectives.

DFMs had authority to buy and sell investments for the client, without needing to obtain prior approval for each transaction, by following a carefully designed mandate. 

Generally, financial planners referred their high-net-worth clients to DFMs for investment advice. The DFM charged a premium for this service, but the relationship between all three (client, financial planner and DFM) worked. 
The effect of new regulationThe Markets in Financial Instruments Directive (MiFID) II and the General Data Protection Regulation (GDPR) have added layers of complexity, not least with regard to who is responsible for meeting the client’s objectives.

Under MiFID II, DFMs now must establish client objectives and communicate directly to the client about the part of the client portfolio that they manage. From a client perspective, this extra layer of ‘transparency’ could be confusing. 

In addition, where a client’s account includes positions in leveraged financial instruments, DFMs must now inform the client when the initial value of each instrument depreciates by 10% and thereafter at multiples of 10%.

When the investment is made via a platform, it gets complicated. Here, the DFM will not know whether an individual’s investment has fallen by 10% or not, and will be relying on the platform to inform the end client. 
Financial planners and DFMs will need to have rigorous procedures for data minimisation, transparency, accuracy, storage and confidentiality DFMs and financial planners are concerned about the effect this communication could have on consumers. How is the client expected to know what impact a 10% fall will have on their lifelong financial plan without it being put into context by their financial  planner? This could cause clients to panic, moving their assets to more cautious investments at exactly the wrong time. It will be up to financial planners to reassure clients that a 10% drop for a short period means very little for a long-term portfolio. 

GDPR complicates matters. Under this new regulation, individuals can control how their data is used, know where it is stored and have a right to transfer or, in some circumstances, erase it. In instances of misuse, individuals will have increased rights to legal recourse alongside existing rights to claim compensation. 

It means that financial planners and DFMs will need to have rigorous procedures for data minimisation, transparency, accuracy, storage and confidentiality. Having clear lines of responsibility and expertise and reviewing these regularly is key. GDPR will probably exasperate clients because financial planners will have to revisit all existing client agreements and ask clients to duplicate and re-sign their consent. 
The benefits of working with DFMsOutsourcing the investment planning to the expertise provided by a DFM lends itself well to a client-focused outcome. According to Fraser Donaldson ACSI, of independent financial information business Defaqto: “The combination of an adviser, expert financial planner, and a DFM, can provide value to a client as portfolio investments are constantly monitored and managed within agreed risk parameters.”

Most DFMs manage client money via model portfolios on platforms. This means they won’t know the client or have any relationship with them. If financial planners and clients require bespoke portfolios, there are two main contractual agreements for this arrangement. First is the introducer or tripartite agreement where the financial planning is down to the financial planner, and the investment management is conducted by one or more DFMs managing part or all of a client’s assets.   

Second is the ‘agent as client’, where the financial planner is the client of the DFM. Here, the financial planner is entirely responsible for putting the client in the right portfolio, following the differing risk parameters for different pots; for example, pension pots and ISA pots. The financial planner's responsibility is to understand that, in terms of risk, they have put the client in the right DFM risk-rated portfolio.  

Clearly, the level of suitability is written or provided by the financial  planner – the DFM’s client – on behalf of the retail client.  

One thing to note here is that when financial planners and DFMs talk about suitability, they mean different things. When financial planners discuss suitability, it’s about meeting the client’s objectives. When investment managers talk about suitability, they are talking about the FCA Conduct of Business Sourcebook (COBS) rules, which refer to suitability to trade. 
DFMs and financial planners mean different things when they talk about suitability Tony Bray, head of client relationship at fee-based IFS support services provider threesixty, says: “If I’m a DFM given a mandate by an intermediary to manage a client’s money in a balanced portfolio, my obligation is to make sure that when I’m buying or selling any asset classes or investment vehicles, that it’s suitable to trade that asset class relative to that investment mandate. Many advisers assume talk about suitability is encroaching on advice. It’s not. The DFM is talking about suitability to trade.”

This ‘agent as client’ arrangement works well for many DFMs. Head of intermediaries at Brewin Dolphin, Antony Champion, explains: “They [the financial planner] know and understand what their clients are seeking to achieve. We will work with that intermediary to provide investments that are suitable to meet their needs, based on specific information provided to us by that intermediary. They simply hand over investment suitability to us and we manage this in accordance with that mandate. Nothing has changed post-MiFID II, other than it has clarified how this model enhances the intermediaries’ service, helps us articulate who does what, and of course has added formal additional layers of reporting, all of which we are providing to our clients.” 

Under the agent as client model, the DFM has little regulatory responsibility apart from delivering on the risk profile as dictated by the planner. 

Seven Investment Management (7IM), finds the alternative tripartite arrangement works well. Robert Hardy, 7IM head of intermediary sales, says: “We operate under the full ‘know your client’ regime. That means that 7IM is on the hook for suitability.” 7IM must ensure that the client fully understands the level of risk they have, that it is widely documented and there is at least an annual check on the client’s risk profile to show that the mandate they are running is in line with their risk objectives. 

The DFMs interviewed for this feature agree that whatever formal responsibility they have, depending on the structure of the relationship and agreement, all financial planners and DFMs should be professionals working collaboratively for the good of mutual clients. According to Charlotte Lambeth, branch director at Charles Stanley Exeter: “There is often more than one way to achieve an objective, so kicking ideas around can be really productive.”
Finding the right DFMThat works in an ideal world, but before financial planners get to this stage they have to do their DFM research, including comparing charges, matching portfolio service profiles with risk profiles, buying into an approach that matches their and their clients’ beliefs and delivering drawdown services.

MiFID II also instructs financial planners to review their discretionary investment management agreements, giving rise to fears that thousands of financial planners may be working with inadequate terms. Some financial planners perhaps have not appreciated the important technicalities and signed these agreements without the appropriate authority from their client to do so.

Fraser says: “If not properly engaged, a financial planner is not a true agent and ought not to be treated as the (professional) client of the manager. In the event of a client complaint about the investment, this leaves the planner potentially exposed.” 

There are a lot of third party firms, including networks and asset risk consultants, doing the due diligence and research on behalf of intermediaries. Paul Hammond, director of Panthera Wealth, a financial planning and wealth management firm, says this brings another layer of diligence to the client experience. “I use a network who have their own investment committee and use a research firm for fund information. The due diligence and research would be too much hassle if I were to do it myself”.  

But financial planners still need to invest time – which has cost implications – to ensure they comply with the new rules. The FCA is concerned that consumers are possibly being overcharged, but also being wrongly classified as requiring a DFM at all.

The FCA’s Product intervention and product governance sourcebook (PROD) states: “Distributors [for example advisers] must have in place adequate product governance arrangements to ensure that: (a) the financial instruments and investment services they intend to distribute are compatible with the needs, characteristics and objectives of the identified target market.” 
When DFMs and financial planners disagreeWhat happens if both a financial planner and DFM identify different suggestions for the client? Robert Noble-Warren, Chartered FCSI, president of the CISI West Country branch and asset manager at Independence Wealth Management, says the fact that a financial planner and a DFM may come to different recommendations for the client is not a concern if the client is engaged enough to decide between them. “If the client is not engaged enough to decide between two conflicting opinions, then I suggest that neither firm can fulfil the FCA COBS requirement that the client ‘understands’ the options.”  

Charlotte from Charles Stanley disagrees. “You have a problem if the objectives don’t align. It is fair to say that there can be a difference between the financial planner considering the overall position of a client, and the DFM looking at what the specific pot of money they are managing is for. The same can be true of risk – we are usually in charge of the riskier end of a client’s overall financial position, whatever their risk profile with us may be.”

Ultimately, it is the financial planner who is responsible for ensuring a client’s overall objectives are met and financial planners must decide if they want to keep clients who are ‘insistent’ and have different views about how to reach their objectives.  

If financial planners, wealth managers and DFMs are using the CERTIFIED FINANCIAL PLANNERTM six-step financial planning process, this will improve the client's experience and there will be less chance of conflicting priorities. The process involves the following steps:

  1. Establishing and defining the client-planner relationship: the services, responsibilities and the fees. 
  2. Gathering client data and determining goals and expectations:  this includes understanding the client’s attitude to risk.
  3. Analysing and evaluating: assess current client situation and offer options to achieve client goals.
  4. Developing and presenting the financial plan with recommendations.
  5. Implementing the financial plan: the financial planner discusses and agrees with the client how and what recommendations will be carried out.
  6. Monitoring the lifelong financial plan: the financial planner will monitor the clients’ progress towards their goals and periodically review with the client and make adjustments to the plan as necessary.

This won’t stop conflicts arising, but it should help to give clarity and understanding between all professionals and ultimately help protect clients.

Seen a blog, news story or discussion online that you think might interest CISI members? Email bethan.rees@wardour.co.uk.
Published: 07 Sep 2018
  • Compliance, Regulation & Risk
  • Wealth Management
  • Financial Planning
  • Mifid II
  • GDPR
  • financial planner
  • DFM

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