How to manage wealth and adjust client expectations in a world of low yields and even negative real interest rates? A conference organised by this news service recently addressed a topic that remains central for the industry.

Sound risk management becomes more urgent amid volatile markets, and asset managers must be agile and mindful of how costs can affect results in a world of low yields, a conference heard recently.

“The most important thing that wealth managers can do is to give clients realistic expectations,” Peter Westaway, chief economist for Europe at Vanguard, the US-headquartered investment house, told the WealthBriefing Investment Strategy Summit in London recently.

“The way investors have in the past responded to episodes like this is by reaching for yield and going out for the risk premium, which on the face of it seems like a smart thing to do,” he added. Among the most useful actions a wealth manager can take is to ensure investors avoid “doing stupid things at the wrong time”.

Westaway was speaking at an event held at the ETC conference centre in the City of London’s Eastcheap. Other speakers in the first of three panels were Dimitris Melas, managing director and global head of equity research for MSCI, and Roger Jones, equity fund manager, London & Capital. Sponsors for the event were Bulletin; Chelverton Asset Management; Dragon Capital; Eclectica Asset Management; ProFundCom; smartKYC; Standard & Poor’s MMD; Vanguard, and Wealth Management Association.

The need to try and eke out returns for a tolerable level of risk at a time when yields are low and prices such as interest rates are near zero, or even negative, has been arguably the biggest headache for wealth managers since the collapse of Lehman Brothers in late 2008. Central bank experiments with low rates, quantitative easing, “forward guidance” and other techniques have forced asset allocators up the risk curve to deliver the goods. 

“When markets are rising by 10 to 15 per cent a year then adding some value to that matters less. In a low-return environment, active management matters more. Being able to protect [clients] from setbacks matters more. Cost is important in all environments but in terms of how markets work, if you have double-digit returns you can afford to pay managers more,” MSCI’s Melas said. “It is, however, a fallacy that when returns are good, costs don’t matter,” he added.

A low-return environment looks set to remain for some time because of a number of headwinds, London & Capital’s Jones said. Deleveraging of corporate and private balance sheets, ageing populations and slowing population growth have contributed to the current position. There are, however, points for optimism as human lifespans increase and technology advances, he continued. “We have to be very patient in waiting for growth to come back,” Jones said.

In allocating assets for a low-return, low-rate world, clients are increasingly understanding that they need to adjust what the future holds for portfolios. “If all this is explained then expectations will be reset,” he continued.

“It is all about understanding where we are in the world and where cash rates are. Most people are fairly understanding of the situation and...not expecting the nominal market rates we saw in the 1990s as this has been going on for a few years.”

One change is that clients are more willing to consider ideas such as co-investment.

MSCI’s Melas said there has been a change in how investors perceive risk. “People used to have a single number. We have seen them move to using a wider number of indicators; liquidity risk has become much more important; there is credit risk, and 'crowding risk'…there is much more use today of scenario analysis and stress-testing,” he continued.

All together
The panellists were asked if it is really possible to find uncorrelated assets when market episodes have demonstrated that almost all assets, even gold, can be pushed in the same direction by a shift in sentiment.

“What we have seen at times of stress when risk premia are driving everything is that correlations go up. As we move back to a more normal environment when it is not all just about sentiment, then bonds will move towards being a counterweight [to equities],” Westaway said.

Asked about alternative areas such as hedge funds, Westaway said “they are fundamentally different ways of organising an asset class. The key is often that you have a lot of manager risk and it is often all about picking the right manager. The devil is often in the detail,” he said.

Correlations between equities and bonds tend to be high – as now – when inflation expectations are low, London & Capital’s Jones said.

Vanguard’s Westaway said there is “plenty” of macro-instability at present. Some of the higher volatility may be technically-driven, because cuts to investment banking and market making have reduced liquidity and price discovery. In the case of bond markets, for example, heavy central bank purchases of debt have taken bonds off the table.

Finally, panellists were asked about whether, in such a low-yield world, asset and wealth managers will suffer, with consolidation and some players quitting the field. 

Wealth management is, overall, light in terms of use of capital – in contrast to investment banking, said Jones. “There are definitely going to be winners and losers but in terms of overall [industry] profitability, it should remain a good place.”

“Some managers in the middle may find the new environment more difficult but those firms able to offer real added value can thrive,” said MSCI’s Melas.