Time for a bit of common sense
Private banks may place great store in academic theories when contructing portfolios, but clients usually prefer a simpler approach.
Is the way assets are allocated by our leading private banks about to change? Soundings from some major wealth managers suggest there is a creeping, and in some places ground-breaking change, affecting which assets are included in clients’ portfolios.
While Credit Suisse has overhauled its benchmarks, raising the status of real assets and commodities, the Zurich giant’s essential adherence to the time-worn disciplines of so-called ‘modern’ portfolio theory (MPT), developed by a group of Nobel Prize-winning US economists from the early 1950s onwards, remains intact.
Still popular
MPT’s disciples use a mathematical formula to determine the optimal proportions of a diversified selection of assets, which they claim have a lower collective risk than any of a portfolio’s individual components. This is a philosophy still shared by most private banks in their dealings with clients, despite the crisis showing us asset prices can move in tandem during critical times.
Several hours away from Zurich down the railway line in Milan – about to get much closer after the completion of the latest trans-Alpine tunnel – UniCredit’s head of private banking investment strategy, Manuela D’Onofrio, paints a different picture. For Ms D’Onofrio, the heroes of portfolio management world are not Harry Markowitz or William Sharpe, the founders of modern asset allocation thinking.
Instead, she laments the recent passing away of Franco-American, Polish-born mathematician Benoît Mandelbrot. He doubted the accepted wisdom of the great and good, who claimed portfolio returns followed some sort of pre-ordained, predictable patterns.
The theory held by Ms D’Onofrio – who on a day to day basis must explain her portfolios to representatives of the Italian clergy as well as Sicilian factory owners – is a pragmatic one. “If you ask me what my mathematical formula is when allocating assets,” ventures Ms D’Onofrio, “the answer is a simple one: I will tell you to use some common sense. That beats any quantitative model of optimisation.”
No pattern
UniCredit’s clients seem to have reached the same conclusion. The bank’s newly-published research into the habits of 100 of its wealthiest clients shows many thought they knew their way around the market before the crisis. Now they realise there is no great celestial pattern which determines earthly returns.
Northern Trust and SEB are also challenging the old beliefs about risk and return. Barclays Wealth says emerging market and interest rate trends must be factored into any new system. But most importantly, believes Ms D’Onofrio, the notion of risk tolerance – meaning how much of your money you are prepared to lose – must be adequately explained to clients in simple terms, rather than those of academic high finance.
