Clients demand new channels of delivery

Before the global economic downturn, most of us in the industry thought strategic asset allocation was fine, but the crisis exposed the fact that the risk analysis on some positions – and products – was wrong.” So says Cath Tillotson, managing partner at wealth management consultancy Scorpio Partnership.The paradigm shift Ms Tillotson describes has resulted in two things: firstly, many investors see a strong argument for fleeting, tactical investments to complement long-term strategic asset allocation. And secondly, the choice of products used for tactical positions – and how these products are presented to clients – has become something of a hot potato.

This means private bankers must now carefully reassess not only which products are best suited for tactical investing, but also how best to handle the thorny business of promoting them to clients. The flipside is a key question for asset managers: how should they market their products to private banks in the new environment?

In the May edition of PWM we looked at how selected tactical investments can be as important as long-term strategic asset allocation. While not everyone agrees on the merits of tactical moves, there are increasingly compelling arguments for investing short-term.

Christian Goldsmith, investment specialist for global balanced solutions at BNP Paribas Investment Partners, which has a 24-strong team of tactical specialists, says: “We do strategic asset allocation to drive longer-term returns but there is always something in there that turns out to be wrong, or at least underperforms, so a tactical overlay is vital in allowing you to manage the downside and gain extra returns.”

The French fund house’s tactical team, which offers a global tactical asset allocation product as well as running segregated portfolios, takes positions of between one week and a year.

QUICK EXPOSURE

If we ask which products facilitate this style of investing, the majority of tactical investors, including Mr Goldsmith, tend to favour exchange traded funds (ETFs) and similar instruments such as exchange traded commodities, useful for quick exposure, via commodities, to various countries and currencies. ETFs are seen as ideal for deploying large amounts of capital fast; sums in the tens of millions can be invested on a same or next day basis.

While investments in active mutual funds can also be executed quickly, ETFs have a huge cost advantage, levying 0.3 to 0.4 per cent compared to 3 to 4 per cent for retail share classes of the average mutual fund.

“For simple tactical asset allocation calls ETFs are cheap and efficient,” says Michael Rist, head of investment advisory services at Bank Julius Baer. “For example, if you want to increase your exposure to equities for some weeks, they are simply the best product to use.”

While it can be difficult to motivate some distributors to sell ETFs, they will become even more appealing in the UK, following the implementation of the findings of the Retail Distribution Review (RDR) in 2013, which will outlaw commission on the retail side. “The RDR will mean all listed products generally coming to the fore,” states Scorpio’s Ms Tillotson.

Finding the perfect fund to support a tactical strategy can prove tricky, says Mr Rist at Julius Baer. “If you want something very specific – say your strongest call on equities is European large cap value stocks – you will have to dig deep to find a fund and you will probably only find an active one that mirrors your idea.”

Liquidity is often the key issue. “If you do tactical asset allocation into an area with funds that are too small, you will swamp the fund but you do not want to own most of it so you have to avoid that,” warns William Drake, co-founder and director at Lord North Street, a private investment office with wealthy family clients.

“We are particularly nervous about funds that are not so liquid, as the whole point of a tactical move is to take advantage of short-term mispricing,” he says.

Burkhard Varnholt, chief investment officer at Sarasin, says the less liquid the instrument, the less suitable it is for tactical moves: “Hedge funds and private equity should not be part of any tactical approach.”

Assuming the private banker manages to track down the right instrument, getting the client to agree to the investment fast is essential. “Timing is everything,” he says. “It is critically important to make sure the investor is invested in the right product at the right time. After all, if you invest at the bottom you could get a 20 per cent return.”

But promoting these products to the prospective client is not always such a straightforward business, claims Scorpio’s Ms Tillotson. “Clients have become deeply suspicious of commissions,” she says and they may also feel uncomfortable with their wealth manager promoting their own in-house products.

Some believe this trend towards independently sourced products can be counterproductive. “There is nothing wrong with offering your own product. In fact, there has been too much emphasis on open architecture,” believes Mr Varnholt, who was among the industry pioneers introducing an online open architecture platform ten years ago at Credit Suisse.

His currently employer Sarasin uses third party providers in particular for index products and money market funds. “But the drawback of all that is that you know other people’s products less well than you know your own,” he says.

Providing the relationship with the client is a strong one, there should be no issue with banks recommending their own vehicles, believes Mr Varnholt. “It all starts with having enough time to both listen to and understand the client. Once you have done that, you have the necessary trust.”

Others argue that tactical asset allocation decisions must be made without thinking about products, in order to avoid a conflict of interest. Mike O’Sullivan, head of UK research and global portfolio analysis for Credit Suisse’s Private Banking business, says: “Tactical asset allocation must be conducted without influence from the product side. The key thing to get right is the macro rationale, ie whether you are overweight financial stocks relative to commodity stocks and so on.”

The overemphasis on product ideas also receives short shrift from Lord North Street’s Mr Drake. “Lots of the recent problems have been down to a focus on products rather than asset allocation,” he says. “There has been a disproportionate focus on products and it is still out there to some extent – and it will be as long as people remunerate their staff based on the margin on assets under management.”

At Lord North Street, he says, they avoid clouding the issue of product selection by ensuring fees are not related to the products recommended. “We give our client complete transparency and our fees are affected by neither the products or asset classes we recommend.” This, believes Mr Drake, allows the firm “to start with a blank sheet of paper with every client and spend a long time getting to the bottom of their risk profile – which can be complex.”

Tactical asset allocators agree that in the post-crisis environment it is best to tell clients as much as possible about the products in which they are investing, however the decision to promote a particular product set is reached.

Major Swiss banks such as Julius Baer typically communicate with clients at least once a month. This is done through investment strategists providing relationship managers with monthly updates on performance and investment decisions, as well ad hoc communications when a specific event occurs. The relationship managers then convey the information to clients in various ways. “They know the clients best, so they know the right means of dealing with different clients,” says Julius Baer’s Mr Rist.

It is vital to keep all clients engaged through this process of relaying the thinking behind execution decisions. “We really explain the process, including how we came to the investment conclusion and why the selected product fits best,” argues Mr Rist. “And from time to time we also say, sorry, it did not work because the call was wrong or the instrument did not act as we thought it would.”

Critics of this process say most institutions fail to communicate well enough, particularly when it comes to explaining the rationale behind making specific tactical investments. “The problem with tactical investments is that you have a responsibility to inform your clients about them on an ongoing basis,” says Alois Pirker, research director at New York-based Aite Group, a consultant to retail banks and wealth managers.

Yet, worryingly, “the communication systems of private banks today date back 15 years – their websites are out of date and they just don’t reflect the modern customer’s consumption patterns.”

A NEW WAY OF THINKING

Clients have smart phones and iPads, they are often on the go and they are already using them to access investment information, he says. So private banks should be providing detailed communication on their investments, including gems from their rich seams of expert research “which often stay buried” in a form that clients can read at their leisure.

“The traditional thinking has been that online services are for those who cannot afford an adviser but even advised clients do cherish their iPads and the ability to consume information whenever they want,” adds Mr Pirker.

These channels are ideal for promoting products for tactical moves, because they can be put in front of the client immediately. “It puts the best thinking of the firm straight in front of the client rather than waiting for it to filter down to advisers,” says Mr Pirker.

He adds that neither is it expensive to deliver this kind of service. “It is not the biggest technological challenge and the banks have the content already – the biggest hurdle is cultural.”

Mr Pirker says a new online service from Merrill Lynch called “Merrill Edge” is a good example of how to communicate effectively. This was originally a platform for the mass affluent but it was opened up to private banking clients “in response to demand”.

For wealth managers, updating their means of communication with clients could improve both relationships and the ability to promote the right products to them at the right time – and hence make the most of those tactical investment opportunities.

Talking tactics

• The majority of tactical investors favour ETFs as their vehicle of choice as they are both cheap and efficient
• Clients have become suspicious of commisions and may be averse to wealth managers who promote their own products
• Clients with exposure to tactical investments need a steady stream of up-to-date information and modern technology that can help to accomplish this

Strategies for the flipside

Wealth managers are not the only ones seeking to promote products, but fund houses can have their work cut out when trying to attract the attention of bank-based allocation specialists to new concepts. Most claim to have little time for marketing ploys or brands, with product selection coming down to the basics of analysing the performance of the fund and the principles under which it is managed.

“We look for good, talented individuals, not strong brand names,” says Sarasin’s chief investment officer Burkhard Varnholt, adding that past performance should not be the ultimate concern. “We prefer forward-looking analysis and looking at what conviction the managers has in the positions he takes.”

Lord North Street uses a combination of meeting managers and systems the firm has built and bought to assess them. “When we talk to asset managers about their products we use a process that mixes science and art: It’s 80 per cent analysis and 20 per cent judgement,” says the group’s co-founder William Drake. “We do not like beauty parades. If a manager has talent it should appear in the numbers somewhere.”

Relationship managers must also think about how a product will complement others deployed in a client’s portfolio. “We use quant to blend managers to create an optimal mix for a consistent return,” says Mr Drake. For global equities, for example, Lord North Street tends to use between five and six managers, while it typically uses two to four for other asset classes.

Innovative products

We asked our tactical investment product experts which new instruments are catching their eye and the result was a list of funds investing in innovative sectors and asset classes.

Dan Draper, global head of ETFs at Credit Suisse, is keen on ETFs investing in commodities, alternative energy and fixed income. “The recent rally in government bonds with long maturities, associated with slowing economic growth in the US and Europe, has forced many clients to tactically increase their fixed income weightings,” he says.

Emerging markets are on the radar for most wealth managers but Cath Tillotson, managing partner at Scorpio Partnership, believes funds investing in the countries coming up behind the Brics (Brazil, Russia, India and China), such as Columbia, Venezuela, Malaysia and Thailand are looking increasingly appealing.

Burkhard Varnholt, chief investment officer at Sarasin is a fan of funds investing in the water industry. He also retains his confidence in all things sustainable.

William Drake at Lord North Street, likes simple quality stock funds. “The quality sub sector is emerging as an interesting place to invest. There are not so many fund managers specialising in this area so there are undervalued companies here.”

While hedge funds are usually insufficiently liquid for tactical investments, the European Ucits III regulations are changing this, says Michael Rist, head of investment advisory services at Bank Julius Baer. “Ucits III is broadening the options by allowing access to liquid and regulated hedge fund strategies,” he explains.