Providing clients with a handhold

The global financial crisis has profoundly shaken investor confidence and reassuring clients has become a top priority for private bankers and asset managers alike. “Clients are concerned about three different levels of risk: market risk, counterparty risk and liquidity risk,” says Philip Watson, head of investment analysis and advisory group at Citi Private Bank EMEA. “To a certain extent, these risks are all related but they can obviously be separated depending on the client situation,” he says. Large parts of the financial markets have been depreciating recently and hence market risk is a very dominant concern for most investors. “It is important that we remain very much in touch with our clients, and that we hand-hold them through this market uncertainty and address any concern that they may have around their positioning,” says Mr Watson. This implies “managing client communications as routinely as humanly possible.” Especially at times like these a private bank can bring a lot of value to its clients, he says. “We help clients to re-orientate their portfolio defensively for example,” says Mr Watson. This can be achieved, for instance, by recommending companies that have balance sheet strengths and that deliver value to shareholders either via earnings growth or via dividend payouts; or recommending particular sectors such as healthcare, which tends to be de-correlated from the rest of the portfolio and offers quite attractive dividend yields, he explains. Citi Private Bank has also been recommending strategies to improve the risk management of clients’ portfolio. “Investors can capitalise upon the very high levels of volatility by writing call options on their equity holdings and therefore generating income. That income either becomes a profit in the event that equity markets remain flat or rise, or that premium can protect the client partially against further downside movements,” explains Mr Watson. “We have to source new information and bring clarity to our clients in response to market events and we are doing so from a very proactive basis,” he says. But clients are all behaving and reacting differently to the credit crunch and it is duty of a private bank to respond to any bespoke solutions they may require. Many private investors at the moment are anxious to preserve capital and to ensure that any further losses that may result from adverse market conditions are limited. And some clients are indeed moving into cash from other asset classes, says Mr Watson. “Some clients are dynamic in their asset allocation and move their asset allocation more in line with their short-term market outlook. That isn’t in my opinion a strategic asset allocation. Strategic asset allocation means building a composition of asset classes that will achieve the investor’s longer-term risk and return objectives.” This way, clients’ portfolios will produce better results on a risk-adjusted return basis. “Some clients, who originally felt they could withstand the risk associated with being wholly invested in equities, are reconsidering their position and moving more defensively,” he says. But the opposite also happens, where clients are positioned defensively, then become disappointed because they don’t benefit fully from equity market rallies. Consistent and constant client profiling is therefore necessary, in order to make sure the client really understands how his portfolio is currently positioned and how it will be positioned to benefit from the market environment, says Mr Watson. Tackling anxiety Counterparty risk is increasingly at the forefront of investors’ fears. “Investors have sought reassurance that their assets are indeed safe, for example looking at the difference between the investment manager and the custodian and what the legal entitlements are for the clients in the event of insolvency or wrap-up of the fund.” Investors should review whether their assets are segregated or commingled as this will become an important factor in the advent of any insolvency, says Mr Watson. Counterparty risk is also dependant on the specific nature of the investment. As a result of the widespread deleveraging in the industry, some hedge funds are imposing gates that restrict access to funds to a percentage of the total value held by the client. Being on top of the situation, keeping in constant contact with the hedge funds has then become necessary, to understand whether, first of all, hedge funds are likely to impose gates and how high these gates may be, says Mr Watson. Similarly, in terms of liquidity risk, because there have been so many situations recently of assets sales and disposals at lower prices, the ability to liquidate positions at favourable prices requires close monitoring of bid and offer prices. “Sometimes the client doesn’t necessarily want to liquidate, but it’s a question of reassuring the client that there is a market, should they want to liquidate,” he says. “So it’s tackling unforeseen events or great market anxiety to see how readily clients would be able to dispose of their assets,” says Mr Watson. “Clients are nervous and what they do value above all else is good and impartial advice,” says Phil McIlwraith, group commercial director at SG Hambros, the private bank subsidiary of French group Société Générale. Banks are put under increased scrutiny. “Clients have been asking us a lot of questions about Société Générale but also about SG Hambros, because we are a bank in our own right, and therefore we have our own balance sheet which we manage ourselves,” says Mr McIlwraith. “Clients are now realising that counterparty risk is a far more important subject than it probably used to,” he says, echoing Mr Watson. “A year ago, investors would have been very rate sensitive. And they would move money sometimes to a bank that was offering a higher interest rate. I think clients nowadays realise that there is a relationship between risk and reward, whether it is in cash or any other asset class. We have noticed more of a flight to quality with regards to cash as well as with other asset classes,” says Mr McIlwraith. In general, clients today want far more transparency. “Take structured products for example, which have a number of components, ranging from the underlying investment theme to the guarantor of the product, if it is capital protected and also its custody. I think clients are realising that all those elements are important,” he explains. Private investors are also concerned that their relationship managers might leave the organisation. “For clients, more than ever it’s important now to have continuity; fortunately we have always enjoyed very low turnover, so that’s something we have been able to reassure clients on,” says Mr McIlwraith. The communication methods have also improved. “We have put more emphasis on our internal communication, because what the bankers need is good information to be able to pass to their clients.” Looking at the future, Mr McIlwraith expects private banks will give more importance to areas like continuous professional development training. “It is important that people are constantly trained and have the right level of knowledge to give the right service to their clients.” Clients will be generally more risk averse and it will take them time to gain confidence in the equity markets. “Diversification has always been important, but I don’t think clients have always perhaps understood the need for it.” The industry has a role to play there, in terms of educating clients, he says. Absolute return vs market return Barclays Wealth’s investment philosophy involves combining a traditional style of market return portfolio, including traditional asset classes, with an absolute return portfolio, including liquid traded absolute return strategies and funds of hedge funds or individual hedge fund strategies. “A lot of those absolute return strategies have continued to perform, although not as well as their historical track record,” admits Michael Dicks, head of research at Barclays Wealth. The firm’s private investors, who on average have a 50 per cent split between market return and absolute return strategy, are now debating whether they should start adding a tactical and strategic asset allocation overlay to their traditional portfolios or increase the part of their portfolios invested in absolute return strategies. “Those are the sort of questions we are increasingly being asked. But the best split for people’s absolute return versus market return strategies isn’t a function of the cycle, but it’s a function of their financial personality, not just their risk appetite, but actually how much they feel the pain of going through a cycle,” says Mr Dicks. For those investors who have high levels of “composure” as it results from the financial personality questionnaire that the firm uses, this is time to start building exposure to the riskier asset classes, says Mr Dicks. So, for those investors who are able to keep longer investment horizons and are comfortable taking risk, willing to lose some money before they gain some potential in, it may be time to allocate to credit, or sectors that have been particularly badly hit like financials, as well as emerging markets, says Mr Dicks. A bit more trading “What our investors expect us to do now is possibly a bit more trading and making sure that we try and avoid the deep layers and, as a result, not go for the tops necessarily,” says Mary-Anne Daly, head of private wealth management at UK-based Cazenove Capital Management. While the firm’s long-term strategic asset allocation has not changed since the start of the crisis, tactically the firm went quite heavily underweight equities, although a bit too early, admits Ms Daly. “We missed the top, we took some money out of equities for our clients and we were overweight cash, which was a good place to be.” ”We then started to buy the market,” she says, explaining that since the big fall in October that was done quite consistently on red days. “Before we were 10 per cent underweight and we are probably now edging towards the neutral equities,” she explains. “This is because we think equities are so oversold right now, that the markets are probably due for a bounce, from sort of now until through the US elections and maybe into early next year.” But those times of constantly upwards sloping curve seen in the past are not going to happen for the next year, she adds. “If we were to connect the dots of the curve from now until same time next year it might be a straight line. So you have to be a bit clever about trading. And there might be a bit more trading, more shifting in and out of asset classes than we would normally expect in our portfolios.” Short-term interest rates are going to fall quite radically, anticipates Ms Daly and so they have tried and locked in the interest rates for their clients, buying some very short-dated bonds. This way, clients can benefit from higher interest rates, before they start to fall. Cash is king Allocation to cash has also been increased. Cazenove’s strategic asset allocation to cash has moved up from five per cent to 15 per cent for high risk clients, to as much as 30-40 per cent for lower risk clients and even to 50 per cent for new clients. “In these kinds of falls, when markets are down as much as 25/ 30 per cent, it is very hard to find a place to hide,” she says. The firm is also looking to slightly reduce allocation to hedge funds. “We are in the middle of a debate right now,” says Ms Daly, explaining that their current strategic asset allocation to hedge funds is 20 per cent, including individual hedge funds and funds of hedge funds. “We haven’t lost faith in the hedge fund industry, but we feel that conditions for them are going to be tougher.” The borrowing for hedge fund is not going to be cheap, prime brokers are going to demand much more risk control. But it may also happen that with the shake out, which is going to lead to consolidation in the industry, the returns on individual opportunities will become bigger for the fewer players; perhaps hedge fund firms will need less leverage, after all. “Maybe that the leverage is going to cost hedge funds more is not such an issue. But it’s a time of reflection,” says Ms Daly. “It’s a time to just stop and examine how the model is going to evolve; we want to see if all the big players survive and how they do.”

BNY Mellon benefits from flight to quality Asset managers are also fighting the credit crunch by focussing all their resources on clients’ service and communication. “At the moment we are not out there trying to sell new products, our number one priority is to help our clients navigate these markets,” says Paul Feeney, head of distribution at BNY Mellon Asset Management. “Our clients are worried about the markets and how to interpret them. They are worried about what strategies they should be in and we stay very close to them, providing daily and weekly updates and, in terms of verbal communication, we give updates often on an hourly basis. We give our views and analysis of the situation so they will make their own decisions.” Providing good robust investment management and fiduciary management trough these markets is essential, he says. Certainly there is a move towards higher quality, towards safety and diversification. “In the equity market there has been a flight towards large caps away from small caps and in the bond area towards government bonds and investment grade bonds over high yield bonds. In the cash market there has been a flight more towards AAA funds. At the same time there has been more of a move towards global equities than single market equities, as investors want to diversify greater,” he says. Also, clients have also been moving to trusted counterparties. All of this has benefited BNY Mellon AM, says Mr Feeney. In the face of large net redemptions across Europe, the firm has registered net positive flows in EMEA, and in UK especially. The firm’s multi-boutique model – BNY uses 16 different asset management businesses across the world which manage around $1,000bn (E778bn) in assets – is a very strong model in this environment, says Mr Feeney. The firm’s breadth of investment capabilities enables the firm to satisfy clients’ needs and to meet their wishes to move from an asset class to another. “We have seen significant flows into balanced and diversified funds and multi-asset funds,” he says. “One of the things I would hope to see is the whole market getting back to the basics of investment management, as there are very few free lunches,” he says. “And the tenets of investment management are diversification, risk management and ensuring that you are investing with people who have got track record and experience in those areas,” explains Mr Feeney.

Philip Watson