Risk on? Risk off!
Spear’s talks to the Brains Trust at Schroders Private Banking about the art of managing risk in 2012
EVEN THE CLIENTS of the bluest of blue-chip private banks couldn’t be blamed for feeling they should panic as they see those around them losing their heads (and their shirts), so it’s more important than ever for bankers to explain to clients the risks they face. Now, risks aren’t always bad of course: from risk comes opportunity. But it’s understanding risk which is key, because once a client is aware of the potential pluses and pitfalls, they can make an informed decision. With that in mind, Spear’s sat down with Rupert Robinson and Kieron Launder, CEO and CIO of Schroders Private Banking, which has £16.5 billion of assets under management, to talk about all the risks an ultra-high-net-worth client faces today. We started with the failure of major banks before the financial crisis to make sure their clients knew what was in their portfolio.
Spear’s: Opacity turned out to be a big problem for banks and their clients.
Rupert Robinson: Schroders Private Banking in London is attracting clients from two principal sources: certain family offices and the big integrated investment banks who have suffered since the credit crisis, for a variety of reasons. Image and reputations, in the case of the latter, were tarnished by losses racked up in their securities and investment banking divisions. At the same time, many of their wealth management arms which had previously prospered from a ‘product sell’ business model, as bankers fed their clients on a rich diet of structured products, hedge funds and private equity, came under pressure. These types of investments have opaque pricing terms and illiquid characteristics. As the downturn gathered pace, the combination of a lack of transparency and illiquidity caused considerable client dissatisfaction.
Spear’s: What’s the situation now with opaque products?
Kieron Launder: The financial markets might give rise to some very interesting opportunities, and that might manifest itself through investment structures, but there is a greater insistence upon understanding the outcomes, perhaps making the structures slightly simpler than they were. We had a structured product evolution where there was a creeping acceptance of risk: people were chasing yields and so incremental changes, or what looked like incremental changes, in structure actually changed the underlying risk quite dramatically. If you take relatively vanilla structured products such as reverse convertibles, as volatility came down, the coupon came down and people said, ‘Well, how can I keep that same coupon or higher?’ There were incremental changes that were happening within the structure that were underestimated.
RR: Another characteristic we are seeing is a desire for simplicity and a move back to basics. In a world of exceptionally low nominal interest rates (negative after allowing for inflation), investors are desperate for yield. This means a greater emphasis on income-producing assets such as corporate bonds, convertibles and good old-fashioned equities, where the focus is on dividends. In a lower return environment, dividends and coupons will make up a bigger portion of an investor’s overall return.
Spear’s: Are people still playing it safe?
KL: There’s a general tone of caution and this is something everyone is sensitive to. When we’re talking about quality, it’s not just quality of the goods or of the service that’s being provided or the quality of earnings — quality of balance sheet is also really important. Being in control of your own destiny, either from a pricing or borrowing/cash-flow perspective is very valuable.
Spear’s: How do you reconcile risk aversion with an inflationary environment?
KL: You’re reconciling that on the basis that with high-quality companies, you’re buying something that may have temporal price risk but is more than likely going to give you the investment objective that you have. For the ultra high net worths the primary objective is wealth preservation in real terms which has to be over a multi-year period. What is likely to satisfy those objectives?
Insurgents in wealth management have been calling for clearer charging structures for clients, minimising hidden fees, commissions and retrocessions. Combined with the Retail Distribution Review, client fees face great changes.
Spear’s: Are there risks HNWs should be aware of in charging structures?
RR: More intrusive regulation and RDR are attempting to provide more transparency for clients. Whether it achieves its objectives remains to be seen. I have my doubts. We have always attempted to provide clarity around how we charge our clients. At the same time, we have tried to be innovative in the way charge them. That means levying fees in the most tax-efficient manner.
Spear’s: What does that mean for Schroders?
RR: We are still working our way through the fine print, but RDR will require us to come up with a new rate card. It will require a change in the way we charge our fees. In the past, it has been tax-efficient to charge UK clients via the management fee embedded in a product (as opposed to at a portfolio level), as this fee is not subject to VAT. This is no longer permitted under RDR. Regrettably, I fear in many instances clients will end up paying higher fees (at least the invoiced element) and more tax.
Spear’s: Are clients at least better-educated than before?
KL: I think they are. Better-educated and more sensitised to losses. They’re asking more questions, which is a good thing. If you come from a background of a service model, of getting close to clients and building a strong relationship, that’s actually a really good thing for both sides.
Spear’s: What sort of things do clients now ask?
KL: They’re much more knowledgeable about areas where there was complexity or opacity before — eg structures, hedge funds.
RR: One of the more commonly asked questions by trustees and clients is: ‘What is the TER [total expense ratio] on their portfolio?’ This stems from a period of very low interest rates and poor returns. In this environment, the spotlight shines more intensely on total costs, as the higher the charges the greater the impact on returns.
Spear’s: Are clients much more risk-aware now?
RR: Clients have definitely lowered their return expectations over the past decade. Most of our clients are extremely wealthy when they come to us. Our job first and foremost is to make sure they stay wealthy. Many of us grew up in this industry in the Eighties and Nineties when a winning strategy was to remain long equity markets and to buy on every dip. Investment advisers were typically judged by how well they performed relative to an equity index. This has all changed. Today there is considerably greater emphasis on delivering absolute rather than relative returns.
The one topic no one can escape now is Europe: it presents both investors and entrepreneurs with different challenges.
Spear’s: What about a giant macro-risk — Europe?
KL: It’s a cloud hanging over all financial markets at the moment, because to a large degree the systemic effects are unknowable. When you look to invest, it has a more dramatic effect on a permanent loss impact within, say, fixed income that it may not have within equities. For instance, if you hold high-quality equities within a country that fell out of the euro, they might ultimately benefit if they’re an exporter.
RR: Over the past two to three years, markets have been dominated by the ‘risk on, risk off’ trade. So far this year we have seen a greater discrepancy in the performance of global stock markets and industries providing more opportunity to make money through good country, stock and sector allocation. As an example, the US technology-heavy Nasdaq index is up 11 per cent while European benchmark indices are lower by 5 per cent. Within Europe, things are even starker. German stocks are up 10 per cent while Spanish equities are down 20 per cent. Overall we remain cautious on the outlook for European equities, but that doesn’t mean there aren’t opportunities. Avoiding banks and focusing on European heavyweights whose earnings are heavily influenced by growth in the developing economies like BMW and LVMH has been a profitable strategy, and one we continue to promote.
Illustration by George Leigh