The world of private banking and wealth management is changing. Traditional wealth managers are increasingly under pressure to raise their g...

The world of private banking and wealth management is changing. Traditional wealth managers are increasingly under pressure to raise their game as investment offerings are becoming more complex, investors more demanding and the market more competitive. Success in this changing world is dependent upon private banks better understanding and satisfying clients’ expectations.

As competition increases those who have long been driven by brand and locality are finding themselves being squeezed by the global private banking players from the one end, and financial planners and retail banks who are moving upmarket from the other. Both of these competitor groups have the ability to deploy significant resource in terms of systems, expertise, brand and high calibre staff, and while consistency is a hallmark of their brands, this must be tailored to deliver local solutions.

The increased promotion of services that is induced by greater competition results in heightened client awareness and expectations. Clients demand more detailed analysis and reporting of their needs, and show a greater interest in the performance of their investments. These requirements are further enhanced by regulatory pressures such as “Know Your Client”, “Treating Customers Fairly”, Basle II and MiFID that are driving asset managers towards increasing the effort required to understanding the client and ensure that they deliver.

Operating efficiently and effectively within this environment requires a sophisticated, systematic and process driven approach. The need to understand a client better no longer means knowing when their birthday is, their favourite wine and the name of their cat; a stable platform that supports a demonstrable, transparent process is needed to deliver a risk-based strategic asset allocation tailored to the client’s needs.

What is Required to Meet Expectations?
To meet expectations, these need to be understood, and for them to be understood they must be placed in context. The client must understand what is possible. This means a clear informed discussion on investment with the client; this can be aided by a behavioural questionnaire. The results from the questionnaire need to be consistently assessed. In doing this they should not lose detail or transparency through aggregation, but be used to ascertain a number of client characteristics which are then fed through to the portfolio construction. A suitable universe of asset classes needs to be established.

A methodical approach has to be applied in translating these characteristics to an asset allocation, so that the direct effect of questionnaire answers on the resulting portfolio can be demonstrated. Once constructed, the solution needs to be presented to the client so that they can understand its characteristics. Alternative approaches can be contrasted, and within the portfolio construction the benefits of the asset classes and their characteristics should be made clear, along with the risks. Having achieved a strategic asset allocation, the manner in which tactical variations will be applied has to be explained to the client, together with any structuring around asset classes to enhance return.

Questioning Expectations
What is risk to a client? Asking them is pointless without a framework to put the question in context. For this reason, private banks are adopting a questionnaire and profiling approach.

This can vary from a short psychometric test through to a contextual behavioural questionnaire. For success with either of these approaches the consistency of questionnaire completion has to be assessed. Not only does the questionnaire engender a meaningful and relationship building discussion with the client, but it enables the private banker to measure the client’s level of understanding.

This approach is easier with a behavioural questionnaire as it relates more directly to the topic being measured and the effect of the answers can be transparent. Talking through the questionnaire provides a good basis for a conversation on the topic the client has actually come to the bank for; investment advice.

Portfolio Construction
Consider the way that an asset manager constructs an asset allocation. This can be simply intuitive for cash, bonds and equities, but what is the effect of currency? What happens if emerging markets, property, hedge funds or high yield are added to the construction? How is suitability in terms of different weightings applied? In the case of alternatives and newer asset classes, what weights should be ascribed?

The wealth manager needs support in the form of a portfolio construction tool that analyses the risk and return characteristics of the portfolio as they build it. This will help them understand the impact of including new asset classes, to see where the risk is being taken, and where diversification is being achieved. What also has to be considered is the transparency to the client, complexity for the wealth manager, and the consistency of output? Most important is the appropriate setting of constraints to create suitable portfolio asset allocations for a bank’s client base.

For this process to have value to the clients, they must understand the output. Volatility, value at risk and tracking error are all measures of risk, but to most clients they are abstract terms. To them the biggest risk is missed expectations. To manage these expectations, past performance can be a useful tool.

Demonstrate Characteristics
By demonstrating how different asset allocations would have performed through familiar economic and market events in the past, the client can start to understand the level of participation of a portfolio in both upward and downward markets. These concepts – risk of regret and loss aversion – need to be discussed with the client. The wealth manager needs to understand what the client will tolerate. This is one of a number of conflicting choices the client will face, as an absolute vs relative return bias; short-term loss vs long-term gain; volatility vs return; income vs capital; and conservative vs alternative asset classes.

At the end of this process the client should have a clear understanding of how the initial discussions and the completion of the questionnaire have resulted in their ultimate portfolio, how this portfolio would have performed through past markets, and the risk they are taking. However, developing such a process has a number of business implications for the wealth manager. They will have to ensure they know how the marriage between tactical and strategic asset allocation can be made to work and determine how much freedom should be given in the portfolio construction process, and how the ultimate risk of the portfolio should be monitored. More pertinently, does the bank have all of the product required to deliver against all the asset classes?