Wednesday 26 June 2013

Wealth Managers: Turn Your Technical Knowledge into a Competitive Advantage


As the wealth management industry continues to expand and mature rapidly, advisory firms face a marketplace with more competition and a dwindling population of high-net-worth prospects who do not yet have an existing advisor in place. This means that wealth managers are continuously challenged to differentiate themselves and their firms as they seek to establish new client relationships.

In this environment, wealth managers—particularly CFA charterholders—who demonstrate a thorough understanding of investment and portfolio management concepts will have a significant competitive advantage.

According to Taking on the Role of Lead Advisor: A Model for Driving Assets, Growth and Retention, a 2011 survey conducted by Knowledge@Wharton, the two most cited challenges that clients face when working with an advisor concern technical knowledge:
  • Understanding why my advisor recommends certain investments
  • Getting my advisor to clearly explain why I lost money and what’s being done about it
Boston Consulting Group’s 2010 report Regaining Lost Ground: Resurgent Markets and New Opportunities noted a similar finding:

“Advisors had only a superficial understanding of some products, which made it impossible to decipher their risks, explain them to clients, and ensure their suitability to a client’s profile.” 

The key to exploiting this competitive advantage is to demonstrate to clients how a solid grasp of concepts at each level of the investment process (security- and strategy-level analysis, portfolio construction, asset allocation, and performance evaluation) translates into client benefits.
Here are a few ways that wealth managers can translate their strong technical knowledge into client value propositions and differentiate themselves from competitors.

Linking Portfolio Allocations to the Client’s Overall Plan

Each allocation in a client’s portfolio serves a distinct purpose: diversification, income generation, exposure to unique risk factors, opportunistic trades, relative value, to name a few. When constructing a portfolio, the advisor expects these distinct purposes to coalesce in a way that will achieve client goals.
Despite the wealth manager’s best efforts to keep clients focused on long-term, portfolio-level performance and goal attainment, the (sometimes) bumpy road along the way often requires discussions at the holding or allocation level.
These discussions require the ability to deconstruct portfolio allocations, explain the role they play in concert with other allocations, and tie them all back to the client’s overarching plan. They also require far more detail than such quick one-liner rationales as “We hold 10% in REITs as a proxy for fixed income” or “Emerging markets help hedge against inflation.” These heuristics tend to leave huge gaps between the client’s portfolio and the client’s objectives.
For instance, in the case of a REIT allocation, a richer rationale might be “Income generation helps moderate the equity market risk that you take in your portfolio. Since fixed-income yields are low and the high-yield market seems overpriced, we made an allocation to REITs to increase income generation. Since REITs have far more equity risk than bonds, we also moved into a lower-beta, small-cap equity strategy.”

Incorporating New Strategies

Nontraditional investment strategies are often marketed to wealth managers by demonstrating how such strategies offer incremental portfolio benefits. For advisors who lack a true comprehension of portfolio theory and risk, these offerings can leave them with a sense of more downside than upside potential. Their judgment tends to be clouded by potential relationship risk when considering new, more complex strategies that could benefit the client but would likely leave advisors in the position of explaining results when disappointing performance periods (inevitably) occur.
Wealth managers who fully comprehend the tradeoffs that come with innovative strategies can more confidently embrace strategies that improve the risk–return characteristics of client portfolios.


Communicating Risk

What risks are high-net-worth investors most sensitive to? Answers will vary, but our work with wealth managers suggests that there are two primary risks that deserve to be addressed with constant vigilance: failure to attain life objectives and shortfalls between expected and realized performance.
Gaining an understanding of clients’ life objectives (and the risks they are able to accept in their pursuit of these objectives) can be greatly enhanced with a solid understanding of how risk can be quantified. With an understanding of such statistical concepts as tracking error, standard deviation (and its shortcomings!), and scenario analysis, wealth managers can better communicate potential downside risk and prepare clients for periods of negative returns.
Taken at face value, historical performance, averages, and medians can often be misleading. Track records do a very good job of showing what happened but don’t do a very good job of showing what could have happened. Advisors must possess the skills and tools to understand both the drivers and the underlying market conditions of historical performance.


Explaining Performance

Clients of all sophistication levels expect their advisors to be able to articulate the factors that influence portfolio performance. Performance attribution concepts, though complex, can easily be simplified so that they are understandable by any client.
This “translation” is far more effective when the advisor possesses a complete understanding of the math behind performance attribution. It becomes far more challenging when the advisor has outsourced most or all of the investment process to a third party.
More than ever before, wealth managers who demonstrate deep technical knowledge of investment and portfolio concepts will find themselves in a favorable position for competing for new business and meeting the expectations of today’s high-net-worth investors.










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