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Finance: Protecting family wealth from the slings and arrows of outrageous fortune

The global financial crisis has dealt a heavy blow to the fortunes and confidence of ultra high net worth families the world over. Simultaneously, avenues that were once considered reasonably reliable for family wealth preservation are now facing extraordinary pressures. 

Equity markets, fixed-interest instruments and commercial real estate are highly volatile. Interest rates sit at record lows, while fears of deflation are rapidly being overtaken by concerns about inflation as historically large injections of public liquidity start to run dry.

Increased government intervention is here for the short- to medium-term. Tax-efficient jurisdictions are under attack from US and European authorities, while global tax rates targeting the wealthiest citizens look set to rise as governments slow down the printing presses and try to recoup the cost of quantitative easing.

Trust in the private banking and fund management sector is evaporating in the wake of failures of competence and ethics – even in Switzerland. And then there's the uncertainty, created by Madoff and his ilk, which still casts an ominous shadow over the entire wealth management industry.

The latest Capgemini Merrill Lynch World Wealth Report won't have restored any confidence either. It estimates that the economic crisis has reduced the collective wealth of the richest families by nearly a quarter.

In such a climate, families are facing one of the most challenging periods in which to preserve their wealth. Many will feel like Hamlet as he pondered whether "to suffer the slings and arrows of outrageous fortune, or to take arms against a sea of troubles, and by opposing end them?"

Not that the situation is gloomy everywhere. In common with their counterparts elsewhere in Asia, India's wealthiest are steering clear of the wreckage in North America and Europe. Domestic equities markets are running at over 5% (down from around 10%), one-year bank deposits are returning some 6% pre-tax, and even two-year government paper yields around 6%.

"There's simply no attraction for families to invest outside India. There's no flight to US Treasury bills," says Richa Karpe, investment director of Mumbai-based Altamount Capital that handles some $5 billion rupees (US$107 million) in family funds.

Nevertheless, the task of preserving capital throughout much of the world does have the appearance of tiptoeing through a minefield. Many families, especially in the US, have taken fright and rushed to withdraw capital from wealth funds. According to research by the US consultancy firm Casey Quirk and the Bank of New York Mellon earlier this year, more than a quarter of all redemption requests from funds, including fund of funds, came directly from family offices and individual investors in a general flight to low-returning cash.

Although strategies are now turning to opportunities, the rush to cash put the entire private-banking industry under pressure to raise its game. As Switzerland's president and finance minister Hans-Rudolf Merz told the Swiss Bankers Association in September: "Some elements of our banking sector forgot our tried and tested values."

In truth, some elements of the industry have disappeared underground. Of the six private banks across Europe approached by Campden FB for this article, all but one refused to comment.

Perhaps it is because private banks are currently devising new ways of attracting top clients back into the fold – or just keeping them there. One result of the past 18 months has been a general lowering of the minimum, pre-crisis wealth thresholds that applied before prestige institutions would open an account. As Valerie Boscat, a spokeswoman for Geneva-based private bank Edmond de Rothschild, told a private banking conference in Zurich in September: "There is now no minimum."

While this will raise eyebrows among the wealthiest who expect to get a best-in-breed service from their private bank, the good news is that many are now reportedly lowering fees for bespoke investment and other premium services for the ultra-wealthy in a general reconfiguration of their models.

In tandem there's an influx of new expertise into private banking as institutions in Europe and North America hire wealth-creating talent from the investment banks and put them to work on behalf of families.

This leads neatly back to Madoff and the fear factor. One of the most disturbing episodes for any wealthy investor can be found on page 42 of the Securities and Exchange Commission's report, where the SEC owns up to having received – and ignored – a tip-off that perhaps history's greatest swindler had taken $10 billion off a single client and then thrown it into his Ponzi pot.

The complaint landed in the SEC's lap from a "concerned citizen" in December 2006, the period when Bernard L Madoff Investments was starting to run into trouble. It warned the regulator that "assets well in excess of $10 billion owned by the late, unnamed investor, an ultra-wealthy, long-time client of the Madoff firm have been 'co-mingled' with (other) funds controlled by the Madoff company … " Clearly judging the note to be preposterous, the SEC failed to follow it up.

The SEC report could make any wealthy investor wonder whether his wealth is safe in the prevailing climate. Here's the world's best-funded regulator missing history's biggest-ever fraud, not to mention failures of due diligence and general dereliction of duty by numerous Madoff associates.

Such glaring failures are behind an imminent range of new initiatives. The Institute for Wealth Management Standards, an independent, non-profit organisation, has as its mission to develop and promote measurable, objective standards to foster responsible wealth management and to protect private wealth holders worldwide.

In the US, new laws that will put private wealth-management firms under the purview of the SEC are currently at the referral stage. Senator Jack Reed's Private Fund Transparency Act will force advisers to private funds managing more than $30 million to register with the SEC. Also on the way are amendments that will require advisers to register with the watchdog under another law, the Advisers Act.

Their purpose, explains the senator, is "fair dealing with customers". The combined legislation should help families make better judgements about their counterparties. However, as compliance authorities point out, even advisers who come below the $30 million radar should want to apply top-tier compliance practices, if only to reassure clients.

Meanwhile, family offices worldwide are taking a harder look at their counterparties. Madrid-based Fundacion Numa, established by the Sanz-Gras family, whose wealth grew out of the automotive industry, has developed a system that withstood the meltdown. As well as a detailed, multiple-criteria process for selecting financial partners, the family retains an independent adviser out of its own pocket rather than allowing him to earn commissions. "Of course, the adviser is an expert but this way we ensure his independence," explains chief executive Alberto Brito.

There's no doubt, however, that the cumulative result has been a general erosion of faith in individuals purporting to do the right thing by their clients. As Stephen Covey, American management authority and author of the best-selling book, The Speed of Trust, which emphasises the significant advantages of observing proper standards of integrity in commercial dealings, says: "There's been a precipitous decline in trust particularly in the financial sector. And lack of trust comes at a huge price. It's like a tax on families."

Speaking of tax, outwardly things don't look good in light of the flood of disclosures by US-based individuals about their investments with mainly Swiss-based banks. UBS alone has handed over the names of some 4,700 clients to the American tax authorities and second-ranked banks in Switzerland, a nation that holds around a quarter of all the globe's private wealth, could be next.

Liechtenstein, once a paradigm of secrecy, is already opening up its books while other states are queuing up to sign bilateral tax treaties. The 58 treaties, known as Tax Information Exchange Agreements (TIEAs), signed so far this year is more than double the number signed in the last nine years combined.

However, it's not nearly as bad as it seems. As David Griffiths, managing associate of Helvetia Wealth, a Zürich and Liechtenstein-based independent wealth management boutique with a focus on family offices, summarises: "If you are a member of a legitimate family in a legitimate investment, you've got nothing to worry about. Honest, straightforward people who are trying to maximise their returns while paying fair taxes will be all right."

As it happens, the Swiss Bankers Association agrees. "I do not agree with tax evasion," insists chief executive Urs P Roth, citing his country's long-standing cooperation with USA and other countries on the issue. "We do not want to protect tax criminals or any other criminals." He believes bankers as well as tax-evading citizens should be charged.

It pays to dig behind the headlines. The OECD is leading the charge against tax havens and secretary-general Angel Gurria is on record as saying that the organisation has nothing against tax-efficient regimes. Indeed he's all in favour of competition between jurisdictions in tax. As he told the latest G20 summit, it's tax evasion – "the dark side of the tax world" – that the OECD is targeting, not tax efficiency. His goal is merely greater transparency in these jurisdictions.

Nor will we see the death of confidentiality for clients. Client-banker confidentiality will continue to apply except in cases of wrongdoing. As Switzerland's president Merz has explained, the OECD standards, which will be adopted throughout Europe, guarantee banking confidentiality.

The long-term solution, says the UK's Society of Trust and Estate Planners, is the provision of tax advice on a global, not local, scale. In a recent report the society concluded that the international investment activities of HNWIs and their families will require advisers whose expertise covers many countries and jurisdictions.

Keith Johnston, the society's director of policy, explains: "Clients want home country compliance and international tax neutrality to avoid additional layers of tax. The main priority for wealthy families is that assets are well managed in financial centres with a strong regulatory environment and access to a wide range of top-flight professional expertise." 

The report predicts the gradual blurring of offshore and onshore tax jurisdictions. In short, purpose-designed tax havens will be replaced by a much broader, and ultimately, healthier climate of tax competition as nations vie for big-ticket investments.

So where do opportunities currently lie? Some, such as Ben Bennett, credit strategist at fund manager Legal and General, see a "compelling valuation picture for corporate bonds". This is because they are still under-priced compared with alternative classes of assets such as gilts.

Others cautiously favour the equity markets, largely on the grounds that so much liquidity has been pumped into the system that the risks of deflation from breakneck, global de-leveraging by banks and companies has been averted. Ed Menashy, Charles Stanley's chief economist and something of a sage on global markets, argues that the equities rally of the last few months has "shown few signs of fading". However, he warns that unexpectedly good profits posted by publicly-quoted companies "are the product of cost-savings and not top-line growth".

While dipping a toe in equities is seen as insurance against an unexpectedly rapid recovery in the markets, most wealth managers incline towards a strategy of protecting the value of assets, given the high current levels of uncertainty, particularly over the medium-term as we wait to see whether we'll end up with inflation or deflation.

In a volatile world currencies offer opportunities, if traded in quantities that don't put other family assets at risk. As always, US Treasuries, German bunds and gilts remain at the heart of a medium-term currency strategy, say foreign exchange experts, but probably not the declining US dollar and the static yen. Longer-term, many are looking at Asian currencies. As Altamount Capital's Richa Karpe points out, the rupee for example has been steadily strengthening.

In general though, as economists like Ed Menashy warn, it all comes down to the massive injections of liquidity. The medium-term performance of the financial markets hangs on whether "they have reached a point where they can stand on their own without the financial and monetary stimuli," he explains. At this stage, nobody really knows whether that will happen. 

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