What should you expect from your wealth manager?

Not many cared for asset allocation until the stock market crash in 2008. When investors rued not having booked profits in the equity markets before the crash, they actually meant that they had too much exposure to equity. If they had booked profits, they would have held some money in cash or deposits, which would have been better than a higher allocation to equity. Asset allocation is the most important decision for an investor’s portfolio, and research has shown that it matters most when it comes to return and risk. How much of the portfolio was in equity before the crash would have mattered more than what specific stocks the investor held, for instance.

Managing wealth is primarily about asset allocation. The basis for choice of assets and the proportion that should be held in each investor’s portfolio depends on his/her objectives and constraints. It is the core proposition of financial planning. While the markets may move up or down, the investor’s portfolio has a specific return requirement and risk profile. A professional wealth manager is expected to manage allocations in a way that the return is closer to achieving the investor’s goal and the downside risks are well within the stated preferences of the investor. To achieve this, a wealth manager needs proficiency in asset class performance, so that he/she is able to read the macro trends and advise clients to modify their allocations accordingly. That is, the expertise a wealth manager should bring to the table.

There are several investors who think that investment managers should make asset allocation decisions. They would have liked the fund manager to move into cash and protect the portfolio before the stock markets crashed. They would like a midcap fund to hold largecaps, if markets corrected. Many financial advisors and wealth managers also believe that since fund managers are investment specialists, they should manage asset allocations. It is an uninformed expectation.

A fund is useful in asset allocation only if it is managed with a specific objective, and remains true to its stated focus. A largecap fund that also invests in midcap muddles up the choice to use it to take an exposure to a specific asset class. The fund manager’s tasks are selection of securities and management of the portfolio, so that the returns are superior relative to a benchmark. The benchmark represents the asset class that the fund focuses on. An equity fund moving into cash will harm the investor’s allocation, since to the investor holding the fund means exposure to equity, and not equity and cash. The investor can also redeem his holdings to achieve a lower allocation to equity and higher allocation to cash. It also makes no sense to pay a two per cent fee to a fund when it holds 30 per cent in cash.

If active fund management is about managing sectors and stocks, active wealth management is about managing allocations to asset classes. A wealth manager’s fee should be a function of his/her expertise in asset allocation. We seem to be far from this proposition. We have variously christened intermediaries such as financial advisors, relationship managers, private bankers and wealth managers, bringing investment products. Some operate at the basic level of enabling transactions, filling up forms and completing tasks. Some operate at the next level of distributing investment products, with no competence in managing asset allocation.

A small minority takes on the asset allocation mandate. The debate about ‘fee-based’ and ‘commission-based’ advisory needs to recognise these differences in competency and quality of service. The armies of bank relationship managers and independent financial advisors that reach out to clients are unable to seek fees because they operate at a lower level. They also advocate ‘lazy’ allocation strategies such as systematic investment and transfer, hoping that risks will even out with time. A fresh look at competency building for wealth management is needed, before we debate about fraud, fees and mis-selling.

The writer is MD, Centre for Investment, Education and Learning