The recent FSA suitability paper has made it clear to advisers what it expects to see in place should they decide to outsource discretionary fund management. It specifies an adviser can either put a contractual agreement in place between the customer and the DFM, or it can retain responsibility for the discretionary management, but outsource the actual management to a third party.
In this latter scenario, the adviser must have discretionary permissions in place, if they do not, then they will be in breach of FSA rules.
Skandia believes there are some off-the-shelf DFM arrangements out there, where the DFM does not have any kind of contract in place with the customer. It also believes that there may be advisers in such a triangular relationship who do not have discretionary permissions in place.
However, it's not just the advisers that need to take care. DFMs and platforms have a responsibility to the end customer too, and all three parties must ensure adequate due diligence takes place:
1. Advisers have the responsibility to ensure the models are suitable for their customers, and control the mandate and governance process.
2. Platforms need to look out for the interests of their customers and must therefore consider whether services hosted on behalf of DFMs are offering clients good value in comparison to other potentially substitutable offerings on the platform.
3. DFMs have the responsibility to conduct due diligence on the platforms they operate on in respect of execution and trading costs.
Attention must be paid to substitutable products. The key consideration is the level of charges being levied on the customer which they may not fully understand.
In some DFM arrangements, the charge to the customer can comprise of a charge levied by the platform, plus an adviser fee, plus a DFM fee, plus a charge for the underlying investment manager, not to mention VAT. Total costs could spiral to over 3% per annum if the customer's outcome is not central to the portfolio design.
Skandia believes the tripartite DFM arrangements adopted on its platform ensures customer interests are met and helps ensures compliance. There is an agreement in place between the customer and the DFM, and the DFM offers a bespoke service for a specific adviser firm and their clients.
Advisers are urged to review their current arrangements, and if they fall short of the required standards set by the FSA, they should consider an alternative investment approach for their customers, such as Multi Manager or risk-targeted funds.
Graham Bentley, Skandia UK's head of proposition, comments:
"The fact of the matter is, customers expect a tailored investment management solution when they use a DFM, and many may not be getting that. The FSA thematic review suggests a number of arrangements shoe-horn customers into off-the-shelf DFM portfolios, which were not created to match a specific mandate. Customers wouldn't expect such service when buying a tailored suit for instance; they would expect it to be at least a matching size, if not made-to-measure.
"There is a service issue at stake here, not to mention the compliance and suitability issues, which could have wide reaching implications for advisers, but also for DFMs and platforms that support such practices."
