Wealthy clients are counting the cost of a dismal year
If 2007 was the best of times, 2008 was the worst. It was a year when analysts estimate at least 10% was knocked off the net worth of the world’s wealthy.
According to the Merrill Lynch/Capgemini world wealth report, average allocations to cash and bonds was a restrained 44% at the start of last year. Net debt was kept down by the landed gentry, due to their love of cash and agricultural land.
But individuals using debt to take advantage of real estate, hedge funds and commercial opportunities lost large sums following the collapse of Lehman Brothers. Analysts estimated that the 50 wealthiest individuals in the Middle East suffered a 12% decline in asset value last year following a crash in oil prices.
Oleg Deripaska, once Russia’s wealthiest businessmen, is now reliant on state support. Huang Guangyu, billed as the wealthiest man in China, is being investigated as part of an alleged share trading scandal. Germany’s Maria-Elisabeth Schaeffler faces different challenges after taking on €11bn of debt after last year’s bid for tyremaker Continental.
This year has started with the wealthy feeling angry over the way they believe they have been treated by fund managers, regulators, advisers, tax authorities and the media.
The middle of 2008 saw a string of advisers jumping ship from large banks, notably UBS, to boutiques where they could escape being blamed for the faults of their colleagues. Towards the end of the year, however, the flow dried up as advisers decided to hang on to jobs in well-resourced businesses, best placed to provide a range of services to demanding clients.
Edward Jewson, chief executive of consultancy Jewson Associates, said: “Things are so volatile that people are holding fire and adopting a wait-and-see strategy.”
Despite discontent with the levels of retention bonuses being paid by new owner Bank of America, Merrill Lynch advisers are not as yet falling over each other to jump ship. One adviser, who left a large bank to join a new firm several months ago, said: “To be honest, I would probably have lacked the courage to make the same decision today.”
All this gives the large banks time to regroup. According to a report published by service provider SEI and consultancy Scorpio Partnership: “The flight to advice will be more important than the flight to quality in the current and future wealth market.”
Sebastian Dovey, managing partner at Scorpio, said the quality of advice being provided will be measured more carefully this year by employers and clients. Wealth divisions have become an important profits motor at large banks, with investment banking and asset management in decline.
Advisers, plus their bonuses, are being measured more precisely by the number of products they place.
Product sales measurement cannot be avoided, despite banks doing their best to disguise the fact from clients. Dovey said: “If you go into a restaurant, you want to have a meal and the good service associated with it. However, from the restaurant’s point of view, it is important to know how many people are buying starters, main courses, drinks and so on.”
One of the big lessons relearnt by the wealthy and their advisers last year was that when the record of an investment looked superb, it probably was not. Wealthy individuals in the UK, for example, bought into US-based insurer AIG’s £5.8bn enhanced money market bond in the mistaken belief it was a bank deposit with a reasonable yield.
Unfortunately, AIG used bonds issued by banks, which hit problems last year to support the yield. In an illiquid market, the fund was only worth 70p in the pound. A pressure group is threatening to take out mis-selling actions against a string of private banks, although 95% of investors’ money has been rolled into a recovery fund.
AllianceBernstein started 2008 with an immaculate reputation as a value manager. It ended it with a new chief executive and funds halved in value, after putting too much money into financial stocks.
The securities operation run by Bernard Madoff collapsed at the end of the year, leaving wealthy investors facing losses of $50bn. Rather than getting returns from investments in Treasury bills and options, it has been alleged that Madoff offered a Ponzi-style return to investors out of the proceeds of new subscriptions. When they dried up, Madoff’s cosy world collapsed.
Madoff regularly worked the US wealth circuit to win clients. More often than not, advisers failed to ask about the way Madoff spent his time and how his firm achieved consistently high returns.
The wealthy will continue selling out of hedge funds this year, but the big problem in 2009 is probably going to be in real estate and commerce, as loans on soft terms start to fall due.
Morgan Stanley has forecast a fall in real estate values by nearly a quarter this year, almost the same as in 2008. Values have already fallen far enough to undermine the security of loans and yields on commercial mortgages exceeding 30% imply defaults are inevitable.
Real estate problems suffered by David Ross, co-founder of Carphone Warehouse, in 2008 led to controversy as a result of him using his share portfolio as security. This could be repeated, given that the use of equities for security against loans has been a regular practice.
Advisers will face an uphill job this year persuading their clients to put risk of any kind into their portfolios. Andrew Rodger, a director of multi-family office Stonehage, said wealthy individuals will only be keen to invest, or nurture, their own businesses: He said: “They will only feel really comfortable working in sectors they understand.”
He said clients have learnt to question the status and security of every investment proposition put to them. He said: “At one point last year, they bristled at the very mention of banks being involved.” Wealth advisers are using every trick in the book to encourage clients to switch out of cash accounts, where yields have fallen.
Government bonds were last year’s preferred diversification option but advisers hope corporate credit will come to the fore, not least because this tends to pave the way for a broader recovery. Michael Dicks, head of research at Barclays Wealth, said: “Credit offers exceptional value but is burdened by poor fundamentals and technicals. Start 2009 short, but expect to get long by mid-year.”
Khaled Said, joint chief investment officer and managing partner of Capital Generation Partners, advises wealthy individuals to appoint discriminating credit managers. But he warns that the generous terms on loans negotiated in 2006 and 2007 will lead to a high level of default.
Some advisers believe that yields of 7% on single A credit provide insufficient compensation for default risks as the business environment worsens. Anja Eijking, head of convertible bonds at F&C Investments, said sales of convertible loan stock by hedge funds have revealed some interesting opportunities. “Convertibles offer some 10% yield to maturity and 40% equity participation in recovering markets,” she said. Certain convertibles with cheaper equity options can yield 15%.
High-yield bonds and venture capital can offer attractive returns, tempting endowments to take a view, but recovery may be postponed until 2010.
Equity bulls are finding it hard to build a strong case in the absence of a corporate bond rally. But Nick Rundle, associate director at Taylor Young Investment Management, said high-yielding stocks will look more attractive as interest rates approach zero. Equity investor Anthony Bolton said the time to buy bombed- out stocks has arrived.
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