Traditional approach to private wealth management misguided, says Edhec
Suitable extensions of portfolio optimisation techniques used by institutional investors can be transposed to private wealth management, according to a study by Edhec Business School.
The study entitled “Asset-Liability Management in Private Wealth Management”, by Noël Amenc, Lionel Martellini, Vincent Milhau and Volker Ziemann, says these techniques have been engineered to incorporate in the portfolio construction process an investor's specific context, objectives, and horizon.
The analysis has great potential implications for the wealth management industry. Most private bankers implicitly promote an asset liability management approach to wealth management. In particular, they claim to account for the investor's goals and constraints. The technical tools involved, however, are often inappropriate and do not give the clients any insight on the risk related to reaching their objectives.
According to Edhec-Risk, while the private client is routinely asked all kinds of questions about his current situation, goals, preferences and constraints, the resulting service and product offering mostly boil down to a rather basic classification in terms of risk profiles with no link to the recommendation.
The analysis shows that taking an asset liability management approach to private wealth management generates two main benefits.
First, it has a direct impact on the selection of asset classes. In particular, it leads to a focus on the liability-hedging and goal-specific properties of various asset classes, a focus that would, by definition, be absent from an asset-only perspective.
Second, it leads to defining risk and return in relative rather than absolute terms, with the liability portfolio used as a benchmark or numeraire. This is a critical improvement on asset-only asset allocation models, which fail to recognise that changes to asset values must be analysed in comparison to changes in liability values. In other words, private investors are not seeking terminal wealth per se so much as they are seeking terminal wealth whose purchasing power enables them to achieve such goals as preparing for retirement or buying property.
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Comments
No breakthrough
There is nothing new with the idea of relying on an ALM framework for private clients. Maximising net equity rather than asset value under some constraints is obviously sensible but is often difficult to implement in practice. You need to make assumptions on expected returns, vols and correls not just for the assets (widely criticized) but on the co-structure bewteen assets and liabilities. Just to make your life easier, you also need to accept that you are dealing with incomplete information set during the calibration process. So, as it is often the case with these models, nothing wrong conceptually but we know so little about the structure of uncertainty describing the distribution of the parameters that the final outcome might be of little help on a day to day basis.