Fund Management

Investment Philosophy and The Private Client

A staff reporter, 29 January 2005

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Most private banking professionals rightly believe that their service is undoubtedly the most important for a client and price accordingly. ...

Most private banking professionals rightly believe that their service is undoubtedly the most important for a client and price accordingly. However, the influence of governments’ aside, the area of investment is perhaps the oldest and indeed the most pure of private banking activities. Private clients vary widely in their financial objectives but there is no doubt that whether the aim is growth, preservation or even distribution, the need for good stewardship of assets is paramount.

Over the last 15 years or so, the broad spectrum of investment management fashion - they like to call it philosophy - has changed dramatically. The baseline is the performance of cash assets and, in the early days many private banks only did just that. Even foreign exchange was a little risky although, as the 747, fax and internet has taken hold, so has familiarity with different currencies. Fixed income has been strongly favoured for many years by asset allocators as enhanced cash – a little bit more return with a teeny increase in risk. We will mention that, as an added value exercise, a real fee over cash management could be charged.

Individual stocks have always been part of private client portfolios, but from the start of the dramatic bull market that occupied part of the late eighties and the whole of the nineties, private clients have been gradually immersed in a much wider range of the market – not such a bad thing in terms of diversification. Good funds managers managed a portfolio of stocks carefully in line with weightings and balances individually suited to the client. Bad managers bought a bunch of stocks that looked right on the day of purchase and then found that they did not have time to devote the effort required to each individual account to get it right. This became worse through the nineties boom as the numbers of accounts mushroomed.

Managed funds were therefore created to save private banker’s time – clients might buy a share in a portfolio comprised of the ‘best’ stocks’, a little like a mutual fund. This enabled fund managers to pick an even wider range of investments that both diversified and hid those that went badly wrong. To be fair, there is no pain without gain but clients often focus on the one bad performer in a portfolio without looking at the successes elsewhere.

Once a client was buying a managed fund he might as well buy a mutual fund. These investments - normally the preserve of the plebeian retail clients - could be re-packaged and sold. This had the added advantage of turning private banks that really were banks into ‘funds managers’ without the expense of hiring an investment team. Mutual funds were very public, people got fired if they went wrong and private bankers could blame the fund manager if something went wrong.

Single mutual funds in regions such as Europe and Asia could be used in conjunction with a domestic management team to produce a ‘global’ portfolio – with little sleep lost on whether the balance of the portfolio was consistent. Single mutual fund investment turned into funds of funds; the added value in selecting managers could be charged for and the private bank could diversify away the impact of any one manager. Funds of funds are especially useful in being able to trade within portfolios without crystallising taxable gains and their use has therefore mushroomed in recent years.

Hedge funds and ‘alternative investments’ burst upon the scene from the mid-90s onwards, promising much but requiring a good deal of investment education to understand. In many ways they are excellent private client instruments – regularly marketed as having premium returns yet with reduced risk and a process that is complicated enough to add fee value. Once again bundling hedge funds diversifies away manager risk while providing a complex product. Current private banking newsletters are full of new managed hedge fund launches. It is the current investment philosophy, yet no better or worse than the rest when the environment is right.

All of these processes can be minimised into the view that the main aim is to take cash and invest it into some form of cash, bonds and equities. The forms are becoming increasingly complex yet relatively few investment managers have managed to find a sustainable consistent way to beat the casino. However, many have found new ways to describe how they might be able to do it. Most investment successes have been due, not to great private client funds management – although there are undoubtedly some great investors out there – but to being in the right place at the right time and marketing it well. For private banks, the key marketer is the relationship manager.

Yet if timing and positioning is fundamental to investment performance are passive funds, which after all can be sold profitably with fees of below half a per cent, not one of the easiest and cheapest ways to gain premium returns while mitigating risk? Passive funds, as an investment fashion for private clients is yet to come.

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