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The rich turn to diversified assets

Alternative assets, as opposed to traditional ones such as cash, equities and fixed income, should be integral to an HNWIs asset allocation. (REUTERS)

By Sunil Kumar Singh

The global economic recovery continues to be fragile with volatility in equity markets and tight liquidity worldwide dampening investment prospects in major asset classes.

Even in emerging markets, the hardening of inflation continues to haunt a sustained recovery. So where are the regional high net worth individuals (HNWIs) putting in their money in these shaky times? Are their strategies any different from their global counterparts?

"Regardless of region, HNWIs fundamentally share a common rationale, and common goals and fears. They seek preservation of capital, and then also have an entrepreneurial desire to grow that capital, with risk appetite dictating how much growth and at what pace. So in this respect, global and regional trends in wealth management are substantially the same," said Michael Dismorr, Managing Director, Deutsche Bank Private Wealth Management, Middle East and Africa region.

He said the biggest mistake people can make when it comes to their wealth management is to look only at how much they can make, and not at how much they are prepared to lose.

"Risk appetite and loss parameters should be clearly defined before entering into any investment decision, and the overall risk characteristics of a portfolio should be understood and continuously monitored. Here the advice and support of the wealth manager is paramount. Integral to managing risk is diversification. Asset classes have different risk/return characteristics and efficiently allocating across asset classes is the basis for consistent capital growth," Dismorr added.


Emerging or developed?

According to the latest CIO Weekly from the Chief Investment Office of Merrill Lynch Wealth Management released this week and sent to Emirates Business, both China and India have increased their reserve requirement ratio and investors believe further action is forthcoming as inflation moves higher in the developing world.

With sovereign risk taking the limelight and US growth hardening, the dollar has proved far more rugged than most anticipated. This has reduced some of the liquidity that was driving emerging markets higher for most of last year, said the report.

Last year, emerging markets experienced substantial demand by global mutual funds when more than $10 billion (Dh36.73) flowed into Chinese stocks alone. However, investors have turned more bearish recently. The recent Fund Manager Survey by Bank of America Merrill Lynch shows that investors are the least overweight in emerging market equities since early 2009, the weekly report said.

This result, the report said, is a significant correction in most emerging equity markets since mid-January, particularly Asia. Within emerging markets, investors are rotating to more defensive regions, such as the Middle East, and focusing on countries with lower core inflation, such as Turkey and Egypt, and greater exposure to the US than China. Strong domestic growth stories or countries where policy progress has to date lain unrewarded (Mexico) are also getting attention, the report said.

Barclays Wealth, in its tactical asset allocation report for the first quarter of 2010 in Europe, Middle East and Africa regions, also favours equities in the developed markets than emerging markets in the short term. "Our suggested tactical asset allocation among the traditional asset classes continues to favour equities, notwithstanding their further rally since September. Within equities, our regional disposition favours the developed Western markets more than it did, and we have used the recent rally in Japan to close our overweight there. We also continue to favour developed markets generally over emerging markets. These marginal changes reflect our belief that the global economy and financial markets have moved into mid-cycle mode," it added.

Nevertheless, some experts believe wealth needs to be deployed in the region that an investor knows the best. "The uncertainty isn't over yet, which means it's better to keep your assets in the region that you better understand and assets that are less risky, said Neven Hendricks, COO, Deloitte Corporate Finance.

However, one of the contrarian trends visible in the regional HNWIs is that they are more diversified in terms of geography than those in the developed world, experts say.

"Based on our recent findings in the Merrill Lynch Capgemini World Wealth Report, we have seen investors globally retrenching to their local markets. The crises have made investors globally go back to the market that they know best, which is their local market. However, in the GCC this trend is less prevalent than it is in the United States and Europe, and our clients from the region are still geographically diversified," said Amir Sadr, Head of Middle East, Merrill Lynch Wealth Management, Dubai.

However, he said the slowdown has impacted investment trends of UHNWIs a lot, and the trend is continuing to change.

"We have seen a big shift in the investment philosophy of our clients over the past 12 to 18 months and it's still continuing to shift. Clients have become more risk averse and are managing the risk of their portfolio more diligently than they earlier used to. What we have seen in the market are three things; first, we are seeing an emerging trend of deleveraging among our clients, second, the concept of risk management is becoming more embedded in their asset allocation strategy, and third is the growing realisation of the importance of a diversified investment strategy and not having concentrated positions," he added.


Sectoral allocation

Liquid assets such as cash, equities or fixed-income instruments are relatively more preferred asset classes currently when it comes to portfolio allocation strategies applied by wealth managers for their clients in the UAE and the region.

"Where our asset allocation is shifting a little is in the composition of the fixed-income portion of the portfolio. We are raising the weighting for corporate bonds (mostly high-yield) at the expense of longer-dated government bonds," said the Barclays Wealth report.

"Cash will be at the top followed by fixed income (bonds, sukuks), equities and lastly alternative investments. In the Middle East there has been a natural affiliation to real estate and despite what happened in the past 12 to 18 months we are actually seeing clients still investing in the property sector. We are also seeing interest emerging in foreign exchange products as a way of hedging and speculating. This region also has a strong affiliation to commodities," said Sadr.

However, he added: "We haven't seen a major shift into Islamic financial products because of what happened in the global financial markets. Some Islamic financial products are also susceptible to market volatility. Nevertheless, clients are turning to more conservative assets such as cash, fixed income and real estate, including Islamic finance products."

Income-generating assets that have some protection against inflation are an attractive investment opportunity at the moment, said Paul Cooper, Managing Director, Sarasin-Alpen and Partners, Dubai.

Investment in other alternative assets, such as private equity, hedge funds and equity derivatives, is also an emerging sector, but the relatively illiquid nature of these assets coupled with risks involved is now seeing little interest from wealthy investors, experts say.

"Private equity and alternative investments are not for everyone. It can be an investment option for some people who have a portion of their overall portfolio allocated to this class. Over the past two years, we've seen our clients looking at illiquid assets less than before," said Sadr.

Investors looking to invest in equity derivatives have also very limited options in the region, experts say. "It will take some time before equity derivatives become a significant diversification opportunity in the region," said Cooper.

"We don't have this option [equity derivatives] in the region, but for Kuwait that has a limited derivatives market (options, that too, only call options). Hence, investors in the region cannot use financial derivatives to hedge their risks. Mostly risk hedging should happen only through dynamic asset allocation strategies," said MR Raghu, Senior Vice-President for Research, Kuwait Financial Centre (Markaz).

In the same vain, the appetite for investment in hedge funds is certainly growing in the region, but wealth managers believe in the current turbulent times clients need to be very careful when investing in hedge funds. "An investor needs to understand that hedge funds have got huge amount of volatility and that's how they make money. With volatility comes the risk, and because of the risk there is always the potential to lose your money," cautioned Hendricks.


Alternative assets

However, despite being risky and illiquid, investments in alternative assets has not fallen out of favour yet with wealth managers.

"Alternative assets, as opposed to traditional assets such as cash, equities and fixed income, should be integral to an HNWIs asset allocation, and very much part of the diversification process. The aim should be to achieve uncorrelated, risk-adjusted returns, and alternative assets substantially provide this. The perception of alternatives as risky asset classes to be avoided ignores the fact that a rigorously screened, clearly defined exposure to alternatives lowers risk and enhances performance. I think HNWIs understand this and continue to incorporate quality alternative assets in their allocation," said Dismorr.

However, he added that lack of liquidity, long investment horizons and lack of transparency are the main risks identified with some alternative investments.

"But again, a rigorous vetting process and a clear grasp of the risk/return characteristics of these investments is necessary prior to investment," he said.

Another pattern in regional HNWIs' asset allocation strategy currently is that there is generally lesser inclination to invest in locally listed funds than global funds, say experts.

"HNWIs do not have too much liking for local funds, as they are active investors themselves. However, they do embrace funds for international markets. Hence, local equity funds mostly cater to the retail segment for the growth of their assets under management," said Raghu.

He said given the financial crisis, the asset management industry in the GCC is experiencing severe stress as assets under management got slashed due to the twin impact of market correction and redemptions.

"Given the sullen environment, it is difficult to attract assets. However, offering innovative risk-based products can attract assets under this environment. Plain vanilla country funds (to which most funds belong in the region) will definitely be out of favour for some time to come," he said.

However, for some volatility in the regional equity markets presents an opportunity as well.

"Volatility is frightening, and we have witnessed some extreme volatility both in the region and globally. But these moves also provide incredible openings. I would simply say that uncertainty leads to volatility, volatility leads to exaggeration, and exaggeration creates opportunities," said Dismorr.


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