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FSA warns on ‘systemic misselling’ from poor DFM risk mapping

Rory Percival FSA

The FSA has warned advisers using DFMs run the risk of ‘systemic misselling’ if their risk profiles are not correctly mapped against those of the outsourced investment solution.

Speaking at a Defaqto DFM conference today, FSA technical specialist Rory Percival said the regulator has seen evidence that some advisers are not ensuring the risk profiles they use are aligned to those used by the DFM.

Speaking to Money Marketing, Percival says: “Risk profiling is the key problem. If an adviser firm is carrying out risk profiling and the DFM is running portfolios which will always have risks associated with them, who is making sure one matches up with the other? Mapping is key.

“A DFM’s portfolio risk maybe different from the advisory firm’s assessment of risk. They need to be matched otherwise you have effectively got systemic misselling on your hands which is not a good place to be.”

Percival added the use of DFMs falls outside of the independence definitions because they are not a retail investment product and therefore advisers were not expected to review the whole DFM market to remain independent if outsourcing certain clients to a DFM.

An FSA spokeswoman confirmed the regulator would consider a thematic review into the situation if it sees significant misselling or large numbers of cases through the Financial Ombudsman Service.

Seven Investment Management marketing director Justin Urquhart Stewart says: “It is an area of concern and quite rightly we have got to make sure risk levels are correctly mapped against those of adviser firms. It is an area that constantly needs to be under review because risk profiles can change from firm to firm and clients’ attitude to risk change over time.”

The Platforum managing director Holly Mackay says: “One of the concerns we hear raised is there can be a frequent mis-match between what the adviser thinks is “balanced” and what the DFM thinks is “balanced”.

“Then you get into the sometimes murky area of who is liable when the client’s portfolio doesn’t perform as expected.”


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There are 13 comments at the moment, we would love to hear your opinion too.

  1. The Platforum managing director Holly Mackay says: “One of the concerns we hear raised is there can be a frequent mis-match between what the adviser thinks is “balanced” and what the DFM thinks is “balanced”.

    And what about what the client thinks is balanced?

  2. Maybe advisers will now realise that by outsourcing investments to DFMs involves still doing proper due diligence on the DFM’s style of investment, investment returns and risk taken in achieving those returns rather than sitting back and and doing little for their “adviser charge” being paid to them by the DFM. Outsourcing still means they have a high degree of monitoring to do. Failure to do so will end in the FSA looking more clsoely at what they do for their money…. whenever that may be.

  3. This problem can not be solved as long as this cod psychological terminology is used. Filling in 7 question questionnaires with clients which show them as say ‘adventurous’ then putting them in an adventurous portfolio follows no logical system that I know and it gives an inappropriate outcome.
    We should not for example place a reckless client in an adventurous fund simply because he answers 7 questions like a lunatic.
    We have a different approach: instead of asking daft attitude, beliefs and values questions we observe the client’s behaviors in all aspects of their financial life, give it a score and arrange investments on the basis that they should be/ can afford to be taking more or less risk with them.
    Psychology moved to behaviorism a century ago.

  4. This is just what we need. Balanced risk, medium risk, what does it matter? Roy is a nice fellow I am sure, but if he wants a defined asset allocation for each risk level, agreed with a DFM, then he is taking the DFMs discressionary powers away! We try to let the portfolio manager have a discussion with the client to discuss exactly what is needed so there is no misunderstanding. So in some cases clients want balanced plus a bit, or fairly racy, but not too much. Its all in the interpretation.

    There issue is if the client wants no risk and they are put into an asset backed DFM, or equally well, a low risk client investing totally in equity investment trusts via the DFM. But once the risk level is over very low, then the aims and objectives, term, ability to suffer loss will be taken into account by a good DFM to provide a proper bespoke portfolio. When a DFM looks after a portfolio he can alter things quickly if he feels risk levels on one particular holding exceed the clients requirements. This reduces risk over a conventional portfolio consisting solely of mutuals.
    Roy, don’t go looking for troubles that don’t exist. Medium, balanced etc is well understood by DFMs.

  5. To this I would like to add the following:

    1. Do DFMs really do that much better than IFAs? What is the evidence?
    2. Even if they do better than IFAS does the extra cost justify it? In other words is the outperformance sufficient to justify the extra cost?

    All difficult to quantify I admit, but I do wonder.

    3. If something does go pear-shaped then presumably the adviser picks up the can – not the DFM. Therefore is it really more risky to outsource than to DIY?

    These questions do presume that the IFA does have a decent grasp of investment and has had some success in managing client money. If not one does wonder why they are involved with investments at all.

    In the case of most DFM who merely use collectives within model portfolios I just have a feeling that the advantage is at best ‘not proven’. However a decent stockbroker who constructs bespoke portfolios in direct equities on a global basis may be an entirely different matter – at least fund management charges are one layer that is removed.

  6. Its seems it doesn’t matter if 2 different professionals differ in opinion of what is balance provided the client is told ‘our balanced and what that means’……its all a farce. Trust is the key to any relationship where advice is given, opinions will always differ and that is what makes us all unique and independent (a clue in the title there!), as is having a clearly understood procedure of explaining and documenting risk and where the client is invested. As long as the communication is there clients do no complain as they understand. So remind me, Gilts in this market – low risk = correct??

  7. Looks like outsourcing isn’t actually outsourcing then.

  8. Harry Katz
    Liability in IFA/DFM relationship depends on the IFA/DFM Agreement. Ours gives the DFM the liability. We don’t charge extra for the DFM moving money around from collective to collective on the Platform that we use (the DFM has access). On the contrary our firm saves on staffing and on admin so we pay the DFM.

  9. When does a portfolio ever perform “as expected”? Can any client articulate just what they expect? Does the FSA expect intermediaries to guarantee that any given portfolio will perform exactly “as expected”. It can’t be done.

    The term mapping is a new one to me. I thought it was all about the investor’s tolerance of volatility and about tailoring a portfolio’s asset mix as closely to that as one reasonably can to ensure that the inevitable ups and downs to which any portfolio is subject aren’t so severe as to cause undue anxiety during the inevitable phases when things aren’t going as well as hoped.

    It’s been many a year since I received a call from any client complaining that the value of their portfolio had fallen more than they’d been led to expect it might.

    For cautious clients stick to Gilts and Bonds. For moderately adventurous clients, choose a prudent blend of bonds and equities. For adventurous clients, choose a more heavily equity-weighted blend. Whether or not you choose to entrust asset allocation to a third party is up to you.

    Only the FSA seems to be hell-bent on making rocket science of everything. Mr Percival may be good at passing lots of exams and getting lots of letters after his name, but just how successful was he as a hands-on adviser? The fact that he now works for the FSA suggets that perhaps he wasn’t. Imposing grand theories on others is rather easier than actually doing the job yourself.

  10. As usual I find myself nodding along with Julians posting.

    The FSA has made something relatively simple excessively costly and complex.

    I look at our DFM clients and compare them with old clients sat in the Sun Life Distribution Bond. My summary would be that for an equivalent risk rating the performance of the old bond is rather better. Why? Because it’s cheaper and simpler.

    However an old fashioned bond would be a difficult product to recommend today because the complexity we have to use to justify our recommendation is unlikely to throw that up as a solution.

  11. I’m not sure why people are so worked up about this. The comments from the FSA, Justin and Holly all seem sensible to me.

    Those using a DFM have work to do in assessing performance and risk. Nobody is suggesting that there is a “right” answer for asset allocation, but with your mix or the mix created by the DFM, following general principles of investment there will be a degree of expectations within a range along the lines that most advisers recognise.

    The issue is surely, have you bothered to check that what a DFM calls low risk (or anything else) is approximately in-line with your assessment. Of course as others have said, lemming like adherence to a “score” is folly without a proper full and frank discussion of the issues, reality, targets and so on.. THIS IS WHAT YOU ARE PAID TO DO.

    For those that can’t be bothered, simply outsource and think the job is done, please either get with the program so that the rest of us don’t have to bail you out when you go bust or please would you hand in your notice at the earliest opportunity.

  12. headbelowthe parapet 27th February 2013 at 7:09 pm

    “Nullius in Verba” (take nobody’s word for it). It’s always prudent to do the sums yourself.
    PwC produce periodic reports for the FSA outlining how they might expect asset classes to perform in the future.
    All you need to do is assign each asset class and each sector a value (of expected returns and expected risk) and map the DFM fund (or indeed any fund) against this and ‘Hey Presto’ you know where they stand against your perception of risk and return.
    You can measure the risk of any portfolio or asset in this way. But I’m sure everyone does this, don’t they?

  13. RegulatorSaurusRex 28th February 2013 at 9:46 am

    “One of the concerns we hear raised is there can be a frequent mis-match between what the adviser thinks is “balanced” and what the DFM thinks is “balanced”.

    And then the regulators come along with another opinion on what is “balanced”.

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