Alan Luk of Hang Seng Bank explains how advisers can work with their clients to identify a realistic risk profile and put in place a suitable investment strategy in the post-financial crisis environment.
Date: Feb 2010
Tags: Risk profile, Asset allocation, Investment strategy, Asset classes
Creating appropriate investment strategies
As the global economic environment starts to recover, Alan Luk said in an interview that inflation is a main theme for relationship managers (RMs) and their clients to be aware of – and to protect wealth against.
Against this backdrop, clients might look to allocate 30% to 40% of their assets into bond or fixed income funds to generate stable income, suggested Luk.
If the global economy starts to move in a constructive way, he said that some clients might want to allocate 30% to 40% to higher-growth sectors in markets with good potential for development, such as China or Brazil.
The remaining 20% should be allocated to alternative investments, said Luk.
But he quickly added that this doesn’t automatically mean hedge funds. Instead it refers to currencies, commodity funds and precious metals such as gold – asset classes which he said have low correlations with the traditional equity and fixed income asset classes.
Luk said that low global interest rates are likely to lead to substantial increases in currency volatility in line with incoming and outgoing trade flows. And unless the US dollar can re-establish its stronghold in the global currency markets, investors must take this into account with their asset allocation.
Overcoming mismatches in expectations
Important for RMs to consider is how they deal with the inevitable mismatch between a client’s risk profile and return expectations.
While some investors might say they are conservative when it comes to risk, Luk said nobody is conservative when it comes to returns – as investors tend to want at least double-digit returns on an annual basis.
RMs must therefore make conservative investors aware of the fact that if they are seeking risk protection, they must give up some of the returns on their investments.
Identifying a client’s real risk profile
Traditionally, a client who opens an account with a wealth provider has gone through the know-your-client process – during which the client completes a questionnaire including questions about the individual’s investment behaviour and experience, and expected returns.
Each institution then has its own mechanism to analyse and turn this information into a customer risk profile.
Before the financial crisis, Luk said this was generally considered sufficient for advising a customer on a suitable investment strategy to match the risk profile. This was then subject to an annual confirmation by the client that this risk profile was unchanged.
However, said Luk, advisers in the post-crisis environment need to drill down to fundamentals, to determine exactly what customers want to do with their capital, for instance whether to preserve it or be more aggressive.
This requires the RM to proactively manage and monitor whether customers are on track with their strategies according to their risk profile.
If a strategy is not on track, Luk said RMs must discuss the investment behaviour and allocations with their customers and determine how best to proceed.
Getting more accurate information
Pre-crisis, Luk said RMs rarely discussed or challenged the answers their customers gave on their questionnaires, despite some potentially contradictory responses.
Following the crisis, this has changed. Luk said RMs now need to openly talk with their customers about any gaps in the risk profile.
He advised RMs to not be afraid to challenge customers to make sure they have answered all questions correctly and accurately.
RMs should then document all details and conversations correctly to ensure a mutual understanding of how the adviser should proceed going forward.
