Leadership on the line

Time-honoured investment approaches have become obsolete. High net worth clients have lost in excess of $2,000bn worldwide since the onset of the credit crisis. Trust is the key casualty. The 2008 meltdown is the immediate cause.

But trust had already been eroding since the bear market of 2000-2002. First, the buy-and-hold strategy was not working, as equities were outperformed by bonds over 5, 10, 20, and 25-year periods. Second, nor was the core-satellite approach working, as actual returns diverged markedly from expected returns. Third, nor was diversification working, as excessive leverage raised the correlation between historically uncorrelated asset classes.

In hindsight, clients discovered they were not managing risk, they were managing uncertainty. One relied on the probabilities of expected returns, the other on guesswork. Now, intelligent asset allocation and high liquidity top the client agenda, according to our last three surveys, sponsored by Citi and Principal Global Investors.

For wealth managers, the emerging approach is a mixed blessing. On the upside, it is raising the demand for asset allocation advice and products. On the downside, it is weakening the current heads-I-win, tails-you-lose fee structure by separating alpha and beta, or opportunistic investing and buy-and-hold investing.

This much is clear from our 2010 survey, involving 240 wealth managers and fund houses. When asked to single out the business models that will deliver the best value to clients in this challenging decade, they saw no standouts from a list of 18 models. Each was unfortunately found to be long on intentions and short on deliverables. Those managers who delivered great value did so because they had put client interest above their own. No wonder attention has shifted from models to those investment basics that promote alignment of interest.

The winds of change

The aftershocks of the 2008 meltdown have left clients on shaky ground. They need a high-touch approach that assures them their wealth managers understand the investment heartbeat of the client as well as the subtle nuances of today’s investment landscape.

A growing number of wealth managers know they can no longer rely on market recovery to bail them out. The black hole of sovereign debt is proving scarier than they imagined. So, they are ramping-up expertise in asset allocation, product innovation, customised solutions and client service.

This is in marked contrast to the last decade, when clients were enticed into alternatives by the fairytale of uncorrelated absolute returns or by the much-hyped ‘prime mover’ advantage, which turned the Harvard and Yale endowment funds into world-class icons.

Products proliferated to the detriment of choice. Being copycats, few were tried or tested, by time or events. ‘Fat tail’ was an alien concept. Many hedge funds were in effect running a Ferrari with Citroen-style brakes. Their replicators promised outsized returns at a fraction of the cost. Risk was stacked up like a wedding cake.

Now, there is recognition that necessity is the mother of invention, generating new ways of meeting client needs, including those they didn’t know they had – ways that isolate innovation from fad. New tools are being used to seek new product ideas and subject them to reality checks before their launch.

These and other changes are necessary, but not sufficient. Their success requires wealth managers to exercise a duty of care and deliver best-endeavour outcomes when investing clients’ money. That means a decisive shift in their role: from remote vendors to close fiduciaries, especially in Europe and the US. Without it, clients now face the worst of both worlds: much pain and little gain.

The new role enjoins managers to promote the non-financial as well as the financial alignment of interest by addressing head on eight critical questions contained in the outer circles in the diagram. Together, they aim to:

• counter behavioural biases that have cost clients dear in the past

• prevent wealth managers from selling products that are not fit for purpose

• offer meritocratic incentives in which gain and pain are shared fairly

• develop common investment beliefs and time horizons

• deliver operational excellence via outsourcing.

The missing glue

All this speaks to a simple theme: the old ways of doing things no longer work. Welcome though they are, however, the new ways risk being as durable as the crisis that provoked them. They have yet to be embedded in the cultural fabric of the majority of wealth businesses.

One reason is cultural dissonance: senior managers say one thing and do another. When implementing a client-focused culture, they have set neither the tone nor the example, relying more on power than persuasion. All that does is to promote bungee jumps where staff boldly set out in the right direction to please their bosses but quietly revert to the old ways.

Another reason has been the inability to cater for the law of unintended consequences. The multi-boutique model is a case in point. It gives talented individuals autonomy and space to generate high-conviction ideas. Instead, it has delivered bulletproof baronies fighting petty turf wars about who ‘owns’ the client. Thus, in many cases, enlightened initiatives have been akin to re-spraying an old car: improving external appearance, not engine performance.

What has been missing is a leadership style that aims to engage ordinary people to do extraordinary things, as done by successful wealth managers. Their top executives have addressed the most frequently asked questions about the client-focused culture:

• direction: what does it mean?

• rationale: why do we need it?

• bandwidth: do we have the right people to deliver it?

• impacts: how will the culture affect various teams?

• deliverables: what is expected of each team?

• incentives: what is in it for them?

The answers have been more honest than precise: in a world of uncertainty, it is better to be broadly right than precisely wrong. These senior executives have sought to blend visionary leadership with hard-nosed nuts and bolts management. They have worked hard to raise the performance bar, upping the ante in pro-actively spotting opportunities. Successful leaders in today’s wealth management sphere are showing restless curiosity about new ideas, while realising their own limitations.

In doing so, they know when to delegate and are setting the tone and example by influencing managers at all levels, eschewing hype and relying on an unusual degree of common sense. This means encouraging teamwork by setting stretch targets for client-related activities, enabling people to achieve them and then holding them accountable within a culture of mutual accountability. All-in-all, such structure and leadership culture is designed to create trust internally within the organisation as well as when dealing with clients, showing empathy and integrity in dealing with colleagues and avoiding blame culture.

Tough times offer opportunities to create businesses of enduring value. A minority of wealth managers are grasping the nettle and tackling things that have long conspired against client interests. The rest have yet to craft a new narrative on what they stand for and what they can deliver. This is their biggest leadership challenge. Unless they rise to it, they will fall prey to the Darwinian forces that are reshaping their industry dynamics.

Amin Rajan is the founder CEO of CREATE-Research

Surveys available free of charge at www.create-research-co.uk