Private clients are making major asset allocation decisions without realising their significance and without appreciating the risks involved, according to Michael Strachan, CEO of International Asset Monitor, an institutional consultancy gaining increased traction in the private banking and family office market.
“People can make the right decision at the wrong time, or they think they have delegated decision-making to their fund manager,” says Mr Strachan.
But the funds manager is constrained by a restrictive benchmark, he explains, so the client has already made the most significant investment decision by choosing an expert in a particular asset class or investment style.
This means many private clients, despite having hired expensive wealth advisers, are in effect making asset allocations themselves, rather than allowing their private bank to do it for them. “A private client may have appointed Goldman Sachs to run part of their portfolio, but he has already decided how much to allocate to them, what to invest in and when to withdraw,” says Mr Strachan.
Risk is so central to portfolio construction, that clients should organise their risk profile first, before arriving at any concrete investment objectives, he believes. “Most people set their objective first,” believes Mr Strachan. “They might say: ‘I want to beat the MSCI index’, without even considering their risk profile.”
But once they have set their objectives, most clients fail to understand the crucial role of asset allocation to the long-term performance of their portfolio. He believes that if they have strong convictions about different economies, these should always be reflected in the allocation.
And using exchange traded funds (ETFs) as instruments to reflect large positions is a further abrogation of responsibility, as the full value of a portfolio cannot be realised without actively managing its assets, he claims.
“A 16 per cent equity allocation to emerging markets in five years time is fully justified,” says Mr Strachan. “But if there are positive attributes to such a view, then you should already be at that allocation today. There is no justification in taking a 10 per cent negative allocation to an area, which will have the best growth after five years.”
The thematic approach
This is one reason why Mr Strachan believes a commitment to strong themes – dismissed by many investment managers and consultants, such as Mercer Oliver Wyman, as a gimmick used to sell products – can be a valuable expression of asset allocation positions to generate returns.
“The thematic approach has a lot of credence,” he says, drawing attention to a form of asset allocation and product selling made popular by smaller Geneva-based Swiss banks Pictet and Lombard Odier, as well as Zurich-based giant Credit Suisse. “There is tremendous added value in becoming more specialist. But who is making that decision about how much to put in each theme?”
Private clients are instinctively drawn to thematic investing, says Michael O’Sullivan, head of asset allocation for Credit Suisse Private Banking, which has identified many investing themes globally over the last five years, including scarcity of water, nanotechnology and alternative energy.
But the asset allocation process takes precedence, before the various compartments are then populated with the thematic products. “We start off with the idea or theme, then the basket of stocks comes after,” says Mr O’Sullivan. “Two years ago, we were looking at trends in ‘feeding Asia’ and we found that tastes were changing, which meant land use was changing and urbanisation increasing.”
Detailed research, including breakdowns of Chinese government statistics on tractor usage, was carried out before a basket of Asian stocks was selected to “play the theme,” says Mr O’Sullivan. “We launched the product in September 2007 and were very pleasantly surprised, as there was a strong rally in agriculture and commodity stocks at the beginning of 2008.”
There is no question of themes being cooked up to sell products, with each one the result of detailed research at a local level, he says. According to Mr O’Sullivan, critics of the process would be hard pushed to say the products used to implement the themes are overly complicated or expensive.
However, it is a waste of time digging up intellectually challenging investment themes if appropriate products cannot be sourced to exploit them. “Credit Suisse, as a bank, is careful to make sure its views are always investible,” adds Mr O’Sullivan.
The Swiss bank’s research department turned positive on equities in June, and from a strategic, 12-month point of view, has skewed client portfolios towards riskier assets such as equities and commodities and away from government bonds. Its strategists like sectors including IT, capital goods and energy, while defensive utilities and telecoms have fallen out of favour. In terms of investment styles, cyclical stocks are preferred over defensives, value over growth, small over large cap and emerging over developed economies.
