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HNWIs: following fashion or investment expertise?

John Clemens is managing partner, Tulip Financial Research Ltd. john.clemens@tulipresearch.com; www.tulipresearch.com

Most HNWIs like to take responsibility for their own investment decisions and are extremely active in managing their investments. It's not wrong, or misguided, if it produces the right results, argues John Clemens

It is a truism amongst investment advisers that asset allocation is the panacea, the Holy Grail of investment performance. They frequently trot out the well-worn statistic that asset allocation accounts for more than 90% of mid- or long-term investment performance, with some advisers being even more precise and quoting 93%. This 93% figure, and indeed the whole asset allocation culture, arose from two short papers published in 1986 and 1991 by three financial analysts . Both papers were poor interpretations of some dubious statistics

As the 1990s' bull market in equities came to a close, financial advisers needed a new expertise, a new mantra, for their clients. In 1999 many high net worth individuals (HNWIs) held two thirds of their investment portfolios in equities, and over the next two or three years saw these fall in value by 20–30%. Those HNWIs with a diversified range of investments suffered least, those that were virtually 100% in equities, even well-diversified equities, suffered most.
 
In the 1990s, clients had grown confident of their investment advisers' expertise in allocating assets across equity classes and in equity fund selection. Now, post-2000, these same clients have become disenchanted with equities and question their advisers' investment expertise. The advisers needed to demonstrate new skills and asset allocation became the advisers' new buzzword, the new approach to investment excellence.

But asset allocation is not a science – it's not even difficult – it's just another word for diversification. This is common sense and even in 2000 most HNWIs had quite well-diversified portfolios, though having two-thirds of their liquid assets in equities was neither uncommon nor indeed unwise.
 
The real skill in asset allocation is in the timing of change but this is rarely emphasised by advisers as timing is both difficult and prone to error. Instead advisers often imply that there are permanent, long term allocation strategies, tailored precisely to different risk levels, that will work consistently over time to the benefit of the HNWI. This has led HNWIs to become do-it-yourself investors.

Between 2000 and 2002 HNWIs decided the time had come to make gradual but substantial changes in their asset allocations. There was no dramatic selling of equities and purchasing of alternatives, just a general reluctance to invest new money in equities or equity-related products. Equities fell back to about a 45% portfolio share, resulting more from a lower or nil allocation of new money rather than from share disposals.
 
This new money was initially held as cash, in savings accounts, money market accounts and similar cash equivalents, so that by 2002 cash was taking close to a 20% share of HNWI liquid investible assets. The next movement was a gradual and accelerating flow of money into a new investment category, property. This was initially focused on residential property and marked a new phenomenon – a sort of semi-liquid investment. HNWI investors used cash released from liquid assets to buy properties, and considered these part of their investment portfolios. To maintain liquidity, many investors forwent rental income and held unoccupied property as their investment.

HNWIs as DIY investors
More HNWIs became DIY investors, as advisers were slow to recommend property investments or to become property experts. By 2004 property investment was taking a 15–20% HNWI portfolio share, a share built up entirely without the use of advisers. Fixed income investment in bonds and gilts showed relatively little change post 2000 though they may have enjoyed some limited growth as an alternative destination for cash. The next significant growth was in pooled property investments, as financial product developers noted the move into property and a mix of residential and commercial property pooled funds emerged.
 
To date there is no measurable sign of an HNWI movement out of property, despite indications that the residential market is peaking. But, when it does occur, it will be a gradual and not a sharp movement.
 
There are signs of major movement into 'alternative' investments: derivative-based structured products. These enable private investors to take advantage of sophisticated investment tools that have been available to institutional and professional investors but have had limited availability to private investors. Their principal benefit is the offer of risk-controlled investments with well-defined risk levels. Needless to say reduced risk comes at a price!

The most popular structured products to date are guaranteed equity bonds that enable investors to benefit from rises in any equity index, for example the FTSE100 or the FTSE250 or Dow Jones, without any risk to their initial investment capital.

Structured products, particularly those linked to equity indices, are proving very popular with HNWIs, who are still smarting from the post 2000 falls in worldwide equity markets. They are seen as a safe home for equity investment as investors move back into equities. Over a fifth of HNWIs now own at least one such product and the structured product share of HNWI portfolios is growing rapidly. The HNWI market for these products is forecast to be worth £40-£50bn within two or three years as penetration reaches 40% with a 10-15% portfolio share. This is a reasonable prediction based on current growth both in take up and in the availability of new structured products linked not only to equity indices but also to a range of other asset classes.
 
Since well before the current cult of asset allocation HNWIs chose well-diversified portfolios, spread across five or six major investment categories. What is surprising has been the ability of HNWIs as a group to change their asset allocation profiles as the market landscape changes. HNWIs are not static, inert investors but active, involved investors. Their activity is not one of fast, short-term buying and selling but of evolution: as the market changes, as investment categories rise and fall, so do the HNWI investment portfolios evolve. They are not believers in static asset allocation, they do not think that one set asset allocation is right for the long term. Instead they appreciate that markets are dynamic and their portfolios need to evolve to meet their investment objectives. Timing not asset allocation per se is the most important factor in preserving or building their wealth.

How investment decisions are made
Tulip defines HNWIs as individuals with a minimum of £250,000 in investible assets who, on average, each own £2m in liquid assets. Those with £15 million or more in liquid assets are excluded, as these are a special class of HNW investor. Tulip HNWIs are not young and comprise senior executives in business or public service employment, top professionals, often in partnerships, and about a third run their own businesses, either founded by them or inherited. They are experienced in finance, but often not in personal investment. They are able individuals with an active and intelligent interest in their investments, and most make their own investment decisions without taking professional investment advice.

They do have professional advisers but use them less for investment advice than for tax advice, for practical investment information and for regular analyses of their portfolios. They believe that they themselves are knowledgeable about investment and well able to decide where and how to invest.

They keep themselves abreast of investment developments and the financial markets by paying close attention to the financial media, particularly the business and financial pages of their favourite newspapers. As change occurs in the investment landscape, they respond actively, and usually in reasonably good time.
 
Their investment choices and actions depend on their circumstances and needs. HNWIs  divide into four broad categories: the old retired; elderly workers approaching retirement; employed company executives and professionals, mostly aged 45-60; and the self-employed or business owners, also mostly aged 45-60.  Each group has different investment needs but all have clearcut investment objectives. They know why they are investing, they know their investment objectives and most believe they know how best to meet them.

Most HNWIs do not think of themselves as rich or even wealthy – just comfortably off. They neither think they can afford nor make effective use of discretionary investment management – or indeed that it would be in their best interests. They pride themselves on their ability to manage their capital and take account of market changes as and when they occur. They move into property as property prices rise; they move back to equities as the markets improve; they move out of investment categories as they decline; they always lag the markets, but they are not too far behind. They are active in managing their investments, and monitor the markets and their investments carefully. They are followers of fashion, not fashion leaders – but they are not slow to act as and when necessary to preserve and grow their capital.
 
It is only the multi-millionaires, those with many millions in liquid assets, who can take real advantage of full or discretionary services from the top portfolio managers. These very rich individuals need this kind of help as their investment management task is onerous, specialised and time consuming. Below this level managing your own portfolio is not a very onerous task, and most HNWIs believe it to be a task best performed by themselves. And as in most cases their investment style is active, cautious and intelligent, who is to say they are wrong?

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