The last financial year has left wealth
managers with a lot to ponder over the Christmas break.
Didier Pitton, product marketing director at
Odyssey Financial Technologies, looks at winning business models
for 2009 – and argues that private bankers should consider
revisiting the way they provide investment advice.

As private wealth management firms feel the impact of the
dislocation in financial markets, investment profiling has become
essential to the provision of investment advisory services, helping
advisers meet regulatory obligations, manage risk and ultimately
increase revenues.

This year private investors and wealth managers have faced an
unprecedented challenge. Private wealth management revenues have
declined and the value of assets under management has fallen due to
the negative performance of some investments.

Attracting and retaining clients has become increasingly tough.
Clients are paying greater attention to their investments due to
market volatility and are more demanding than ever. There is a huge
appetite for information on risk and a flight to safety with
investors taking their business to more conservative financial
institutions. In addition, the trend towards holistic advice by a
trusted adviser has taken a knock. Clients have lost confidence in
single providers and are spreading their risk with a larger number
of financial institutions.

Many wealth managers have been blamed for the poor performance
of clients’ portfolios. In order to prevent more fallout and
potential legal action, wealth management firms will need to
implement stricter processes to protect private investors and to
ensure investors understand and manage their portfolio’s risk.

In addition to advice, clients want greater involvement in
investment decisions and more regular and in-depth updates.
Detailed guidance is needed on the risks of investment strategies,
the instruments proposed, how risk materialises and how abnormal
market conditions could impact portfolios.

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Redefining advisory services

Wealth management firms must redefine their investment advisory
service – what does the service exactly include and how is advice
provided? What commitments do firms make to their clients in terms
of monitoring and information? How do we charge for the service? It
is crucial for firms to define their service-level agreement (SLA)
for investment advisory highlighting the benefits of their advisory
services over execution-only services and encouraging
execution-only clients to move to advisory relationships.

Investment advisory services result in better investment
decisions and have a positive impact on clients’ investments. In
addition, research shows that by converting clients to a structured
advisory relationship and setting out an investment strategy,
financial institutions improve revenues, build immunity to
difficult markets and increase investment returns for clients.

One of the key elements of the investment advisory SLA is
investment profiling. As the cornerstone of investment advice,
investment profiling consists of understanding a client’s risk
tolerance in relation to his or her current financial situation and
future financial needs, and then proposing the most appropriate
risk profile and related asset allocation.

Another important element of the investment advisory SLA is
portfolio monitoring. Wealth managers must constantly monitor
client portfolios against the agreed investment strategy and take
action if significant differences are revealed in order to protect
the client’s interests.

Explaining risk to private investors

Attitudes to risk have changed overnight and investors are
making significant adjustments to their portfolios. The use of
increasingly sophisticated products within portfolios has also
impacted the way in which risk is perceived.

Advisers can effectively help clients to manage portfolio risk
by establishing a “risk budget” with them. This budget, which can
be expressed in percentage of “value at risk” (a well known and
accepted risk analytic), can be used as a limit for the portfolio
construction and management. If the markets become riskier, the
“value at risk” may exceed the agreed budget and require
adjustment. This helps to identify which positions and classes have
biggest impact on the global risk of an investment portfolio and,
therefore, need to be reduced.

The advice procedure can be enriched with ‘what-if?’ analysis
and risk suitability checks. This allows advisers to test trades
before formally proposing them to clients, so the resulting
portfolio snapshot is compliant with its risk tolerance budget. In
such cases, risk is used as a decision support tool to identify
which positions and asset classes contribute most to the global
risk of a portfolio (so they can be reduced or increased) and,
secondly, to simulate the impact of a series of buy and sell orders
on the risk of the portfolio.

Several financial institutions providing wealth management
services have already gone through the re-definition of their SLA
for investment advisory with considerable success.

In order to scale investment advisory services (for example, to
offer the service at a reasonable cost while respecting the
commitments of the SLA) most firms have implemented business
technology to allow wealth relationship managers to automate a
large proportion of the work and meet regulatory and compliance

Protecting portfolios

Rigorous asset allocation and the use of quantitative risk
analysis has proven to be the best way to protect portfolios
(relatively) from dramatic falls in stock and corporate fixed
income markets.

While asset allocation has not avoided negative returns, it can
reduce the level of loss and the volatility. Odyssey’s client
research shows that private investors with no asset allocation
suffer more than those with an asset allocation due to a lack of
diversification and poor risk management.

Numerous studies demonstrate that asset allocation contributes
to portfolio management performance much more than product
selection (picking).

In the aftermath of the 2008 financial crisis, destabilised more
risk-averse clients are demanding more than just execution-only
services and basic investment advice. They are looking for
structured high-quality investment advice and are prepared to pay a
fee for it if financial institutions are able to demonstrate the
added value of their service and commit to well defined service
level agreements.

Winners in the post-2008 financial crisis will be those private
wealth management institutions that re-visit the way they provide
investment advice and take this critical service to a new