Justifying the price tag of renewed client focus

In the wake of the 2008 global financial crisis, wealth managers worldwide have initiated actions to regain investor confidence, according to the Create-Research programme. These have focused on disparate areas such as asset allocation, incentive structures, client service and operational excellence. Specifically:

• 30 per cent of managers have created asset allocation products that minimise concentration risks

• 40 per cent have implemented meritocratic incentives for their staff that link their bonuses directly to their performance

• 25 per cent have changed their fee structure to deliver better alignment of interest

• 35 per cent have improved the quality of their client service

• 65 per cent have sought to improve their operational excellence

The list is indicative, not definitive. But it is long enough to underline the point that all sections of the wealth industry recognise the current debt crisis may be a drawn out affair, during which client retention has to top their corporate agenda.

Retail and high net worth investors have been profoundly shaken by the wild market swings since 2008. With an ageing population in the West, many are left with little time to recoup their latest round of losses. More critically, the global financial crisis exposed the heretofore underappreciated risk in the financial system itself.

“The unfolding of the global financial crisis wasn’t random, but a culmination of a series of breakdowns in the financial ecosystem,” observes Neeraj Sahai, CEO of Citi Securities and Fund Services.

“As a result, investors not only lost their appetite for risk assets,” he continues, “but disengaged entirely from a financial system whose inner workings were beyond their understanding.”

There are some positive straws in the wind towards restoring confidence. For example, the recent upturn in the US economy may stem the net outflows from mutual funds invested in US equities. The prospective implementation of the Retail Distribution Review will serve to minimise conflict of interests in the UK. Similar initiatives are likely in the rest of the Europe and parts of Asia.

However, for now, caution characterises investor behaviours. Continuing uncertainty created by the current sovereign debt crisis on both sides of the Atlantic is a major contributory factor. Many investors accept that these are unusual times, and, the extreme market turbulence in August 2011 resulting from the continued euro crisis has made them more informed and demanding.

Turning crisis into opportunity

Clearly, managers will have to intensify their current efforts at restoring confidence. This much is clear from our recent consultations with global wealth managers. They highlighted four areas where further improvements are in progress:

• Doing dynamic asset allocation

• Moving towards solutions-based investing

• Becoming a trusted advisor

• Soliciting regular client feedback

Hitherto, asset allocation has been largely strategic (rather than tactical) and narrowly based on equities and bonds. Today, not only are wealth managers revisiting this approach, but the very theories underlying portfolio construction are also being questioned.

Yes, niche asset classes (emerging markets, hedge funds, credit) are being added to the mix, but equally important are the changes to the process itself. Whereas mean variance (aka Modern Portfolio Theory) was used in the past, today, strategies are being stress-tested against extreme macroeconomic scenarios to ensure that they are fit-for-purpose and sufficiently liquid.

Finally, tactical tilts are becoming more common so as to capitalise on good buying opportunities thrown up by periodic dislocations of the sort experienced regularly since 2008.

The second area covers solutions-based investing. In the defined contribution space, target date funds are gaining traction inside and outside the US. Wealth managers are crafting similar advice-embedded products. Some package them to target specific outcomes via product assembly. Some have stand alone products that target clients’ expressed needs. However, in both cases, there remains a strong need for a better dialogue with clients.

The third area covers the trusted adviser role. Around 25 per cent of managers are giving a lead to the rest by adopting this role – directly or indirectly. To start with, they have set up independent dedicated in-house panels which ensure that clients are sold products that meet their risk tolerances and liquidity needs. They have augmented these by offering greater investment transparency via a disciplined process, backed by regular timely accurate information on returns, their deviations from benchmarks, and suggestions on bridging the gap through best execution.

“If the breakdown in market infrastructure has caused clients to tune out,” says Mr Sahai, “it only follows that offering them improved transparency, more timely information, and better insights into the mechanics of the market will restore trust and increase engagement.”

The final area covers regular client feedback. Around 20 per cent of asset managers now do regular client pulse surveys on performance numbers, product choices and service quality. They serve to raise the level of financial education while meeting day-to-day needs. The resulting engagement serves to solicit new ideas on products and solutions, manage expectations of what can and can’t be delivered in today’s challenging environment, and raise awareness about new investment opportunities.

Together, these four sets of business basics aim to put clients at the heart of everything. They are being implemented in the spirit that these extraordinary times present opportunities to create businesses of enduring value by tackling the factors that have long conspired against client interests. Those managers who have been active in these areas are seen by their clients as competent fiduciaries who exercise duty of care for their clients.

A growing proportion of wealth managers see this fiduciary role in minimising ‘wrong time’ risks caused by a herd instinct that needlessly burnt many portfolios over the past 10 years. At the same time, they know that regaining investor confidence is a matter of hard graft, not bold fixes. It is about doing the right things and doing things right – and persevering while markets have their roller coaster rides.

Of course, there are cost implications. Wealth management is a fixed cost business which cannot be leveraged in today’s erratic markets. Client-focus has a price tag that may not be easy to justify while markets remain turbulent. Yet, for those who have implemented improvements, there has been immediate pay off via higher asset retention. They expect the real pay off to come via more assets under management when the worst of the crisis is over.

At any rate, they see inaction as a more expensive option in the medium term. After all that has happened lately, it is unwise to rely on markets alone to raise investor confidence. Wealth managers have to adapt to a prolonged environment in which they have to be seen to be going the proverbial extra mile for their clients.

“From where we sit,” observes Mr Sahai, “wealth managers have tremendous opportunity to import best practices from the institutional world, not only in terms of portfolio construction, but also with respect to deploying reporting tools that increase transparency and strengthen accountability to their clients.”

Examples of good practices are aplenty. Time will tell whether they will galvanise the late adopters.

Amin Rajan is the founder CEO of Create-Research