The after-effects of the financial crisis on Asian investors’ risk and product appetite, and their wealth management relationships in general, has made it more important than ever before to review the advisory process with behavioural biases in mind.
Date: Oct 2010
Tags: Asset allocation, Portfolio construction, Diversification, Behavioural finance, Bias, Advisory process, Suitability
The after-effects of the financial crisis on Asian investors’ risk and product appetite, and their wealth management relationships in general, has made it more important than ever before to review the advisory process with behavioural biases in mind.
The objective is clear. Relationship managers (RMs) and other advisers need to help their clients overcome psychological and emotional biases towards a more rational and tailored asset allocation as part of stronger portfolio and risk management to support individuals’ goals and needs. And in the process regain client trust and re-instill confidence.
Yet finding a way to structure and implement this in practice, to incorporate behavioural finance into offerings and service models efficiently – both from a delivery and cost perspective – is what wealth management organisations of all types and sizes are grappling with.
To discuss and debate these issues, several experienced market practitioners came together in an exclusive panel discussion in Hong Kong in late September 2010 to discuss the growing role, importance and integration of asset allocation and behavioural finance in Asian wealth management.
A new investing landscape
In general, wealthy individuals in Asia have gone back to basics in their investment strategy in the two years since the financial crisis struck. This means searching for transparency and liquidity, as well as only buying products they understand.
“Investors have in general been shocked into understanding more about what they are investing in,” said Bryan Henning, head of global research and investments for Barclays Wealth in Asia. At the same time, he added, people have a reluctance to lock their money up, preferring instead to be nimble.
Essentially, added Rosita Lee, head of private banking and trust services at Hang Seng Bank in Hong Kong, investors are now more aware of the need to manage risk in their portfolios, as well as of the consequences of get-quick rich investment products.
In addition to transparency and liquidity, Asian investors now also want products with low fees, said Helen Ng, head of private clients and portfolio management for GAM in Asia.
“We have also seen a lot of investors shunning hedge funds given the correlation between asset classes during the crisis.” However, said Ng, looking at the second half of 2009, certain trading strategies – such as macro strategies – saw net inflows of funds given their traditional non-correlation to traditional asset classes.
Yet a lot of mainland Chinese investors are still aggressive and demand high returns, observed Sidney Sze, president of the Hong Kong Society of Registered Financial Planners.
In Europe, meanwhile, wealth managers say they have seen two extremes in terms of how clients responded to the crisis.
Said Marcel Dillier, head of product services and solutions for LGT Capital Management in Switzerland: “For long-term investors, who know that it takes patience in order to achieve investment goals, while they have been disappointed by the recent performance, they are pleased to see LGT’s consistent investment process, especially since this allowed them to benefit from some of the upside in 2009.”
On the flipside, he explained, risk-averse clients liquidated most of their investments and continue to sit in cash. “I think this is a poor asset class because it results in investors missing market rallies, especially since most of them don’t re-enter the markets at the right time.”
Making sense of investor behaviour
Rather than the post-crisis moves by many investors towards short-term, liquid and transparent products being based on rational decisions, however, these have tended to be the result of knee-jerk reactions to the markets.
Only the more experienced investors and advisers understood what was happening, so tweaked their portfolios accordingly and rode out the crisis, said Henning at Barclays Wealth. For the many Asian investors who were investing largely irrationally pre-crisis in 2007, they didn’t jump out during the crisis.
Added GAM’s Ng: “Investors seldom make a rational decisions regardless of the market being good or bad. Clients in good markets, for example, want to chase after profit and avoid missing out on opportunities which their friends might have taken advantage of. And in bad times, they put so much of their money in cash that they might miss out on opportunities when markets recover.”
As a result, she said, wealth managers need to be able to help clients make more rational investment decisions.
Indeed, said Sze, it is normal for clients to show extreme behaviours, so RMs need to play the role of a “psychologist” to ensure clients don’t under- or over-react.
Different investors also use different institutions for different services, added Lee at Hang Seng. “So we cannot force a client to use a particular model as it depends on what their needs are,” she said. “This makes defining a clients’ objectives critical, as well as ensuring we know what they want to use the banks services for.”
For example, if the client just wants to use the bank as a broker, then it is important to ensure operational efficiency to meet their needs, she explained. On the flipside, if a client puts all their assets with a bank, the RM needs to spend more time with that client to service them more fully.
“We are at an inflexion point at the moment,” explained Henning, “where some investors who suffered bad losses will sit on the sidelines for a while. They are looking for a new educational tool and hook to get back into the markets.”
According to Diller at LGT, loss aversion is key for investors. “So it is important to put in place strategies which reduce the risk of experiencing a shortfall after the client’s set investment horizon. Many clients don’t understand volatility and how to read it, so the key thing is to avoid losses wherever possible.”
Another major bias which influences investor behaviour is following the crowd, he added.
“Investors are often sucked into a trend when it is too late,” explained Diller. “Taking a contrarian approach, however, can work, by betting against a trend. For example, if a high-quality stock closes 10% down on a particular trading day, and everybody advises against buying it – perhaps investors should buy it.”
In general, Lee said that if RMs take the time to build relationships with all clients and explain to them much more about the benefits of taking a broader wealth management approach, this can often gradually create more trust, and clients might then disclose more information to the RM.
This all makes behavioural finance an interesting tool, added Henning, but the challenge is how to educate investors accordingly and monetise this approach.
Adapting the advisory process in practice
As a starting point, Dillier said institutions can make more use of questionnaires to serve as checklists to structure discussions between advisers and their clients.
RMs can, for example, ask questions like what kind of returns the client expects under normal market conditions. “Advisers can then see if this is realistic or not depending on the type of portfolio the client wants to have,” said Diller. “If it isn’t, further analysis can be done.”
He explained that at LGT, the advisory process includes a number of scenarios for its clients depending on potential economic outcomes, and then ranks these scenarios on how likely they are to occur. “This enables a portfolio to be structured which is well-positioned for certain situations,” he said, “such as inflation or recession. Advisers then have to be prepared for the existence of uncertainty.”
Knowing about clients’ investment history into particular asset classes is also a key way to assess whether they understand these asset classes and their risk and return characteristics.
Perhaps a key stumbling block to a more scientific or behavioural-led approach to wealth management is the fact that many advisers in Asia assume their clients just want to carry on investing based on tips and other irrational drivers.
Plus, noteworthy about the traits of Asian investors – and equally, something which makes it yet more difficult for advisers – are the very different behaviours across the region, said Henning.
People also tend to take a contrasting approach to different parts of their portfolio, he added. “On one hand they keep a lot of money in cash, and on the other they chase aggressive returns.”
The key to adapting how advisers engage clients within the advisory process, therefore, is a process which teases out the different assets a person has, coupled with their objectives, said Henning
“For example,” he said, “an Indian millionaire might have made most of their money through their business, and is now trying to get into investing. But have they got the same objective for their investment portfolio as for their business?”
Or for a wealthy individual from Hong Kong, who might have made most of their money from property, do they expect to make the same return from investing in mutual funds, asked Henning?
“So understanding clients’ objectives is key to advisers managing their relationships,” he emphasised.
One way, he proposed, to address some of these issues is to take a balance-sheet approach, where advisers can separate out on the one hand personal and emotional assets, and on the other opportunistic investments. The adviser can then have a conversation about an individual’s medium- to long-term objectives, and it is more feasible to use asset allocation.
“Without this type of approach, emotions can take over and advisers can end up selling the wrong asset class to the wrong client,” said Henning.
In Asia, however, too often RMs are eager to please their clients rather than split out different parts of their wealth to have more structured conversations.
This makes it important for RMs to be trained to avoid falling to psychological traps, said Diller. “If they are aware of these traps, they can better deal with the various biases of clients.”
It is also important for clients to do a consolidation of their assets in terms of what is liquid and illiquid, added Ng. “By doing this, advisers can know what their concentration might be.”
Again, the challenge comes from the fact that this is easier said than done. In particular with Asian investors, Lee said they often don’t tell their advisers everything about their portfolio or their total net worth. “This means advisers need to be patient and spend as much time as possible with their clients to really understand their needs in totality,” she said, “rather than just the small portion of their wealth which they have with the particular institution.”
It is common for it to take at least 6 to 12 months before advisers can properly understand clients’ needs and overall position, added Lee.
Then RMs would be able to move beyond simply applying model portfolios mechanically onto every individual. This is also not appropriate, said Lee, because customers are likely to have multiple portfolios – for example for retirement, or for children’s education, or for trading.
“So if RMs can help clients identify their different needs, they can determine which portfolios are most suitable in different circumstances, and then adapt them to fit risk appetite and time horizon,” she explained.
According to Sze, RMs also need to know more about real estate to reflect clients’ interests, and be aware of the fact that their expectations are often based on the returns that have seen through their real estate investments.
Avoiding a one-size-fits-all advisory approach
Key for Henning is that the industry avoids trying to find a single solution – since this doesn’t exist.
“There are different sub-sets for different clients,” he explained. “Some are self-directed, some want to be fully advised, and some just want to be guided.”
The mistake that many firms can make, said Henning, is trying to have one advisory function which, although it gets supplemented by certain specialists, is essentially one advisory model. In reality, he explained, clients are choosing which types of institutions they use depending on which services they want.
“The key is that [the approach] has got to be flexible,” said Henning. “There is no one-size-fits-all approach.”
However, even if various tools or frameworks are developed, the question is whether the majority of advisers are trained appropriately and experienced enough to implement them, and without inserting their own biases into the process.
This is a particular problem in Asia, said Ng, where the rapid growth in private banking has led to a varying range in the quality and different capabilities of bankers.
This puts the onus on the management team to match RMs with experts when advising clients to align thinking.
Perhaps most importantly, using the house view and knowing where the institution is positioning clients en masse can be useful in helping RMs put more composure into the advisory process. “This gives the less experienced RMs the tools and back-up so they don’t have to deviate in more volatile times, rather than them panicking when difficult times arise,” said Henning.
It is also important that organisations avoid setting goals or targets around the application of behavioural finance, he added. “It is about taking a more strategic approach, which includes training RMs so that they are more aware of the biases.”
It also comes down to being able to measure the effectiveness of any behavioural-related advisory processes.
Aside from the LGT approach, which Diller described, of creating funds in Europe which take into account things like loss aversion, practitioners acknowledge that it is hard to measure.
In most instances, by understanding clients’ needs and constructing more appropriate portfolios to meet them, RMs will see over the long term that their net assets with those clients will grow, said Henning. “That is the tangible way to see the effectiveness of taking that approach.”
While there is unlikely to be a dramatic change overnight, behavioural finance-led asset allocation will lead to better relationships over time, in turn meaning growth in assets and a better balance between asset inflows and outflows.
“It is not a silver bullet, but a good deepener of relationships,” explained Henning, “and maybe then the client who only wanted to show you a small amount of their net worth will show you a bit more.”
