The Quest for Optimal Asset Allocation for Asia’s HNWIs

A ‘Fab Four’ of investment experts at the fourth discussion of the Hubbis Asian Wealth Management Forum surveyed the prevailing themes and trends facing investors in the current uncertain conditions. They looked across at the US markets, where valuations appear stretched but momentum is still in its favour. They looked at Europe, which offers pockets of value, but considerable political and economic challenges. And they surveyed Asia, where valuations are modest and economic growth robust, but where momentum has yet to propel an upward re-valuation. And they looked across at the alternative, illiquid markets, including private equity, precious metals and other assets, to see how they fit into a well-adapted portfolio. The overriding conclusion was that these somewhat uncertain times offer opportunity, not a cause for dismay.

The Key Takeaways

Flexible approaches required

Clients need good advice and best-in-class ideas and products, and asset allocation. They do not need fixed and preconceived ideas on active versus passive, and advisers who exclude rather than include. Comprehensive portfolio formation that reflects a genuine understanding of the client needs and a broad array of types of assets and geographies and sectors is vital.

Good times, bad times

If there was a generalisation in the discussion, it was that active strategies are preferable in more difficult market conditions, as quality tends to outperform down markets.

De-risking in the face of volatility

Greater volatility today, and since February 2018, should be reflected in a de-risking of HNWI portfolios. Stay invested but be more cognizant of adaptations to improve the risk-reward profile.

Don’t ask for it all

To build DPM assets, banks and advisers would do better to seek only a portion of the typical Asian client’s assets, and alongside that offer open architecture to achieve best-in-class outcomes for the clients outside the discretionary portfolio.

Be transparent

Clients see transparency as a key factor in their asset allocation amongst wealth managers. The more information the provider can be as to their approach to fees, they better.

Go more conservative

Some experts advised that in light of the uncertainties the world faces, stay invested, but tend towards defensive sectors and income-paying stocks and safety net fixed income, with low leverage and solid, predictable free cash flows.

Go less liquid

Private investments, especially private equity, should form a sold portion of portfolios, as this helps the clients take a long-term view and achieve more balanced returns, over time.

Outlook uncertain

When quizzed for their views on the markets looking ahead, the best outcome one guest expected is a rise of about 10% in 2019, with selective Asian markets doing somewhat better than that. However, the most compelling feature of their replies was that there is considerable uncertainty about growth in the US market and also over the sustainability of such high valuations, driven as they have been by continuing momentum in recent years.

The Discussion

An asset manager began by explaining his approach. “We are a B2B operation, we ask the clients what they want, we create the product the client wants, and then we manage it, including regular delivery of fintech reporting. Our client base has principally been in the UK, but more recently the Middle East and Asia, although in this region regulations tend to limit the availability of optimal products, so for example with an insurance wrapper, pension regulation or the local regulations in the market might limit the asset classes you could use, or might limit the duration you can put in terms of your products, or restrict structured products or hedge funds.”

Horses for courses

Drawing on more than two decades of experience, he remarked that the world is not as definitively active as it was. “We would all like to believe that money should go to companies doing well and that will do in the future, that bad companies should not get the capital. But of course, in the real world, a lot of active managers have struggled. We researched and found that there are in fact market phases where the active manager does well. As an example,   emerging markets when they’re going up, go passive, but on the way down go active - quality does better to the downside, but not so well in the bull market.”

The best of both worlds

“You need both worlds to achieve performance,” said another expert, meaning both active and passive strategies. “For fixed income we much prefer the active solutions versus the asset class solution, which suit some markets and situations, especially more difficult conditions, and there is the factor investing, and smart beta product, which will also gain momentum moving forward, as they provide a very interesting middle solution in certain cases. And let’s not forget the volatility, so long-short hedge funds, which also are good solution in certain market configurations.”

The active versus passive debate, said another guest, depends on the type of client. “Often,” he said, “clients will expect returns of 10% or 12% a year and say their risk profile is conservative, but they must understand that you have to take risks in order to achieve those kinds of returns. So we must communicate with the clients and make proposals that relate to their expectations and also reality. Value, for example, is a relative term, so we have seen in recent years that expensive gets more expensive and cheap stays cheap.”

De-risking

“You need to adapt to the environment,” he continued, “so the key is to add value by using all approaches. All too often clients are doing things because they are busy, their banker calls them up and gives them ideas and they say go ahead. But our approach is to achieve what the client wants to achieve and with the right approach, not in an inconsistent way. De-risking portfolios is a vital part of the approach, as all too often clients do not understand the risks sitting in front of them.”

He added that in a family office environment, there is a very different approach from working in private banks. There is no drive to meet certain budgets. “We make our money in the business of looking after the clients, not in the markets.”

He conceded also that there are times when clients leave the family office because returns are not what they expected. “This is when there is a mismatch between expectations and reality. You will never satisfy every client, but if you can achieve 90% to 95% I think you have done well.” And time is the true gauge, as returns need to be measured over a longer period, not just one year at a time.

Open mindedness and client-centricity

Another expert noted that the first step is to identify the kind of exposure that the firm wants for its clients, with no set prerequisite in terms of active versus passive. “Completely open architecture for the investments, and even open architecture when it comes to where we book our clients,” he reported. “the client needs to see that we can offer a whole suite of products and booked across multiple venues.”

“Traditionally,” he explained, “we have been very much focussed on discretionary portfolio management and that still remains in terms of our focus. But what we have seen in Asia over the last few years is the increasing need for customisation, be it focussing on trust planning, wealth planning, income investing, or other areas. Asian clients want a lot more direct exposure and indirect involvement. And in terms of our positioning, we are going for more private and illiquid assets as the add-on to the liquid public market assets.”

Ask not for the world…

He added that the firm’s DPM role – roughly 35% of the AUM - is in much managing our client portfolios, multi-asset classes, equities, fixed income and fund of funds, but that the demand is definitely diminishing on the fund of funds side and going towards a lot more direct exposure.

He gave more insight into the firm’s DPM operations. “We do not see it as a replacement for advisory, we place it alongside. If the client has one hundred dollars, we do not ask for that in DPM, because we know Asian clients want engagement, more transactional flows. But at the same time he wants a certain pocket to be managed with maybe capital preservation or downside risk management, so we say look, give us one third of the portfolio as discretionary and for the rest we will engage you with ideas or our own ideas or from other institutions.”

Be transparent

“We aim to be transparent throughout,” he added, “so increasingly in all the portfolio proposals that we bring to clients, we disclose total expense ratios, even at the fund level, drilling down to not just management fee but total expense ratios because at the end of the day the clients should know I think very clearly and very transparently what he or she is getting advice on, what he or she is buying, and if we can offer a more efficient solution.”

As to market positioning in the current and anticipated environment, he remarked that as  so many asset classes are very correlated currently, a more balanced asset allocation is advisable, with a tendency to more of a barbell approach and private assets part. Seeing the volatility of 2018 and where markets are now, the key takeaway is to continue to stay invested in equities, bonds and spread allocation.

Balance to downplay correlation

A fellow panellist took up the point about correlation. “I don’t think the volatility we are experiencing today is really much different from volatility we had previously. The more important factor is the interest rate environment and the change of the curve this year, as this is a game changer, bringing some positive fuel to the market, and we believe it will continue. So, stay invested, focusing on the right sectors which are really providing returns and results, and on more conservative dividend-paying stocks, low volatility assets on the other side of the risk curve. That is the kind of portfolio we will build today, as well as including some private investments, alternatives, and some gold as a protection.”

As to private equity, he noted that prices are increasing due to demand, especially in real estate, but clients are more committed to staying in as there is no mark to market and liquidity is modest at best. “It’s good because clients are forced, somehow, to be longer-term investors, so they are less subject to volatility. But we also need to recognise that liquidity is very important if there is any significant crisis.”

The topic turned to women and wealth management, with a guest noting that women today represent 33% of global wealth, and that is rising fast. “As to strategic asset allocation or tactical asset allocation,” one guest remarked, “I think tactical these days is a waste of time. It is interesting that when clients comes in as couples, the risk profile of the portfolio tends to adjust down, indicating that women perhaps are more pragmatic, take a much  broader perspective on what that family wealth is actually supposed to achieve.”

To close the discussion, the experts gave some of their personal views on the outlook for markets.

Forecast – sunny intervals, possibility of storms

“Equity markets will be down at the end of this year from where they stand today,” said one guest. “I fear that the gains made will be wiped out but I also fear that the world’s going to go absolutely crazy on quantitative easing and that there is a new brand of economics out there that says you can borrow forever, after all Japan has almost proven it. A serious economist just said just keep borrowing keep borrowing until the bond yield finally goes up.  So, my fear is that prediction will be totally wrong - the central banks will just inject even more cash just to keep the powerful populist story going and we’ll be at an even crazier level on asset prices.”

“My view,” stated another expert, “is that global equity markets probably will be up about 10% for the year. There is value and there is good traction. And there is a 10% premium on Asia in certain markets, in emerging equity markets. But we must all remain nimble.”

“I cannot predict in numbers,” said another panellist, “but I feel this is definitely a year for more defensive income strategies. Dividends, free cash flow low leverage. At the end of the year, we’re moving towards elections in the US, and there is the volatility caused by trade wars. Asia, of course, remains very much driven by where the Dollar is going. In the Us, there are some indicators, for example from the autos sector, that the economy may not end up in the 3% growth range by the end of the year, but more like 2% which may be the new normal. From an earnings perspective Asia is the place to be, but be careful about the dollar vulnerable countries like the Philippines and Indonesia, which can tend to sell off in this kind of market.”

“The way I see risk,” said another guest on closing the discussion, “the best is behind us, so I think the key is to preserve what you have achieved this year and try to incorporate a lot more risk management. We are in a very unpredictable environment where the action and reactions are causing a lot of unpredictable end products. My advice is to try to build a portfolio based on your clients’ expectations and needs, then monitor it, make the adjustments that you need to make. The key is to manage the volatility that I think is inherent in today’s markets and then avoid the accidents and take advantage of the opportunities.”