Ten years ago, it was obvious in the context of investment what core and satellite portfolios meant. The core would generally be a large passive portfolio, delivering stock market beta, while a group of satellites would be looking for alpha from either active management or alternative asset classes.
However, the credit crisis has helped boost professionalism across the board, and the traditional core/satellite arrangement is being superseded by an array of heterogenous solutions, as wealth managers develop more sophisticated approaches to deal with the difficult climate and disappointed clients. Asset managers are leading the way, but private banks are keen to play catch up, with groups such as Pictet increasingly channeling expertise developed with pension funds and institutional investors to their high net worth clients.
Improving construction
At Société Générale Private Bank, for example, Stéphane Wathier, global head of Portfolio Management, has arrived in Paris from the Luxembourg subsidiary, with a brief to improve portfolio construction. “Asset allocation is probably well applied in asset management firms but not so well in private banking,” says Mr Wathier.
“Although there is good capability, there is a big variance in portfolio management and many different techniques are used. The first problem we encountered was that clients often ask for concentrated portfolios but it is difficult to master risk in this type of portfolio,” he explains.
“Five years ago, we built up a strong process of selection with two main goals – a portfolio with a maximum of 30 to 40 names and a strict approach to risk. The process is based on a quant screening tool that ranks and selects stocks to build up a core portfolio based on fundamental criteria, and then to subject those names to The APT Risk Management Tool (ART) to produce a portfolio with roughly 20-25 names. This portfolio is rebalanced on a monthly basis. To this core portfolio, we add a satellite portfolio – which we define as a conviction portfolio of 10-15 stocks, which is very important from the client’s point of view.”
Société Générale Private Banking implemented this strategy in Luxembourg in 2004-5 and is now in the process of rolling it out across the private bank. “I’m convinced our experience in Luxembourg delivered good performance,” says Mr Wathier. “The problem we often encounter in private banks is that portfolio management is either centralised or delegated to the client relationship manager.”
If centralised, then there is a need to somehow define asset allocation and core portfolios while giving freedom to the local manager to select some stocks to ensure he remains comfortable with the situation, explains Mr Wathier. “But you can see, especially in Switzerland, often it is the client relationship manager – the commercial side – who does everything related to portfolio construction. Our position is to push the portfolio management more towards the client and to structure the investment process, even though we drive it, so the local manager builds the portfolio but within the rules of a strict investment process.”
Changing attitudes
The crisis has transformed investors’ attitudes to their wealth, and pushed wealth managers to take greater interest in client objectives. “The overarching trend we’ve identified over the last two years is our clients’ desire to compartmentalise their wealth, so one thing we’re doing is identifying clients’ needs in two categories – a lifestyle portfolio and a wealth transfer portfolio and for large clients segregating these two functions,” says Leo Grokowski, chief investment officer at BNY Mellon Wealth Management.
“As a reaction to the last two years, more clients want to see, feel and touch a portfolio that is dedicated to meeting their day-to-day lifestyle and their requirements through retirement. Before it was more about structuring the portfolio for the benefit of the next generation, so while for years the industry approached those two needs with one portfolio, now the short-term and long-term assets are often held in separate portfolios.”
The core lifestyle might for example include core equity portfolios, inflation hedgers and diversifiers such as managed futures, funds of hedge funds and 130/30 funds, while wealth transfer portfolios might include long- term assets such as private equity, aggressive hedge fund exposure such as single managers, concentrated equity portfolios, and distressed opportunities in real estate and loans.
This is an example of a larger trend variously called ‘purpose-driven investing’ and ‘objective-driven investing’, which aims for a complete and thorough understanding of clients’ balance sheets and future liabilities. This improves the dialogue with the client using terms they understand, rather than complex jargon such as Sharpe ratios.
Portfolios are usually then designed to comprise five different buckets: principal preservation, inflation protection, income accumulation, capital growth and enhanced appreciation.
