PI warning over adviser DFM outsourcing

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Professional indemnity insurers are concerned advisers are failing to effectively risk manage their relationship with discretionary fund managers.

PI broker Howden Insurance Brokers associate director Umesh Puri says as more advisers outsource to DFMs, insurers are worried there is a lack of clarity over which firm is liable in the event of a complaint.

Puri says: “The most likely cause of a claim is a misunderstanding of the investor’s risk appetite by the fund manager.

“The regulator will not tolerate mismatching contractual terms, risk profiles that do not map across or any failure to assign clear responsibility for knowing the customer.”

Experts warn advisers must clearly articulate the client’s risk profile to the DFM, and provide oversight of the DFM’s investment strategy to ensure it continues to be suitable for the client.

PI broker O3 Insurance Solutions managing director Jamie Newell says: “It is important that advisers ensure the DFM maintains the investment philosophy that was advised at the outset and does not go off piste.”

DFMs say they take different approaches to ensure liabilities are clear.

Tilney for Intermediaries head Miles Robinson says: “The key point of contact for the client is always going to be the adviser, but contractually there are different models in place.

“Tilney has two different models: the introducer model, where we are responsible for suitability, and the adviser model, where the adviser is responsible for suitability. With the latter we are still responsible for implementing the adviser’s mandate correctly.”

Beaufort Group chief executive Andrew Bennett says: “We have a contractual relationship with the client. But where the DFM only has a relationship with the adviser, there is a grey area around who would be liable in the event of a complaint about investment management.”

Brewin Dolphin says it breaks the advice process down into four parts, with the adviser responsible for a needs analysis, assessing suitability and assessing the appropriate risk level. Brewin Dolphin is responsible for managing the portfolio to the risk mandate provided by the adviser.

National intermediaries manager Robin Beer says: “Advisers determine risk levels in different ways so there is the potential for a DFM to misinterpret risk categories. We have our portfolios reviewed by Distribution Technology and Finametrica to minimise this.”

Capital Asset Management chief executive Alan Smith says: “If an adviser determines his client is a balanced risk investor and a DFM implements something that is too risky or not risky enough, there is a strong expectation that the adviser should be providing oversight.

“The IFA cannot just recommend a DFM and forget about it – they need to carry out ongoing due diligence to ensure the DFM is keeping to the brief.”

Expert view: Umesh Puri

Many advisers are reviewing their involvement in managing clients’ investment portfolios, leading to an increase in outsourcing to discretionary fund managers.

While the decision to outsource to a DFM may be partly driven by a desire to reduce risk, the operational model is evolving rapidly and in some respects risk management has not developed at an equivalent pace.

The potential for confusion around the notion of product and service, the precise nature of the relationship between adviser, DFM and client and the tension that may exist between commercial considerations and compliance requirements has created a complex area with the potential to go spectacularly awry. How much due diligence is an adviser expected to do before deciding to outsource to a provider? Exactly what services do advisers receive when they decide to outsource to a DFM? Who owns the client when a DFM is involved?

Understanding your clients’ requirements and appetite for risk is the starting point. If the adviser acts as the surrogate client, they will struggle to discharge their duty to ensure the suitability of the discretionary service and must, therefore, be able to articulate the client’s requirements to a DFM. If the DFM takes up this role, the agent as client model breaks down and the DFM assumes adviser responsibilities for ensuring the suitability of  investment decisions.

Both DFMs and advisers have suitability obligations to the same client. If one is failing in that duty then both may be culpable. Over time greater clarity will be provided by way of regulatory reviews . PI insurers’ concerns will either be allayed or realised but for now they maintain a watching brief.

 Umesh Puri is associate director at Howden Insurance Brokers