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.
