The problem with DFMs: Who is the client?

In my experience, an ever-greater number of advisers and planners are choosing to outsource investment management, allowing them to focus on what they do best; advise and plan.

Developing a Centralised Investment Proposition and outsourcing investment management to a Discretionary Fund Manager (DFM) is clearly one option that’s becoming more popular:

  • Defaqto’s Adviser Survey found earlier this year that among the advisers surveyed 72% of new business had gone to DFMs
  • A survey in 2016 by threesixty of 130 advisory firms found that 87% regularly use DFMs, up from 78% in the previous year

The threesixty research found that the most common reason for outsourcing investment work was to avoid risk and reduce liabilities.

However, I believe some advisers and planners are making a fundamental mistake, which could defeat those extremely sensible objectives.

The devil is in the detail

When I review the existing arrangements between advisory firms and discretionary managers I see two major issues.

Firstly, a lack of clarity in relation to the responsibilities and liabilities of both parties.

Secondly, clauses which automatically transfer responsibility for complaints about the underlying investment to the adviser or planner.

There’s no firm guidance from the regulator relating to the relationship between DFMs and advisers or planners. It’s therefore a case of relying on the agreement made between the two parties. Unfortunately, I’ve seen instances of some DFMs taking advantage of the advisory firm.

These agreements are regularly set up on an ‘agent as client’ basis, where the adviser or planner is treated as the client, not the end investor. In my view, this leaves the advisory firm exposed in the event of an investment-related complaint from the client.

Take for example this clause, which isn’t untypical, from one DFM’s contract: “Any complaint received by us or the Platform Provider from a Client in respect of our discretionary management service via a Platform shall be referred to you.” I’m not sure that most advisers and planners would see that clause as being consistent with their objectives of avoiding risk and reducing liabilities.

“But I’ve never had a client complaint.”

We’ve seen a decade long bull market. Even excluding the possible triggers of Brexit or the escalating situation in North Korea, we are likely to see markets correct, crash, or fall (select your preferred verb) at some point.

When it happens, we know some investors will choose that point to complain.

If your agreements with DFM partners aren’t watertight it’s you who will be on the hook. Not the DFM.

I’m not alone

There are others equally concerned as I am.

Only a couple of months ago the PFS said that advisers and planners “(should) review their discretionary investment management agreements amid fears that thousands may be working with inadequate terms.”

Keith Richards, Chief Executive of the PFS also said: “We have identified widespread confusion in the market on this issue. The lack of clarity around responsibilities where advisers and DIMs (Discretionary Investment Managers) are providing services to the same underlying client means many advisers believe the DIM is responsible for far more than they actually are, creating a potential ‘suitability gap’.”

It’s clear that in trying to avoid risk and reduce liabilities, the agreements some advisers and planners have with their DFM partners results in precisely the opposite outcome.

The solution?

Review your existing arrangements and seek clarification or changes where necessary. Furthermore, question DFMs you plan to work with hard on responsibilities and liabilities of each party.

Be prepared to walk away too; as we’ve heard somewhere else this year; no deal is better than a bad deal!