From the February 2009 issue of Wealth Manager Web • Subscribe!

Where Were You? Who Are You?

Wealth management and investment management have always had a complex relationship: On one hand the concept of wealth management is meant to be juxtaposed--or even opposed--to the opportunistic pursuit of returns implicit in the investment management concept. On the other hand however, investment management is the central component for the integrated services represented by the wealth management concept. The two terms have always had friction that has not been fully resolved--in fact, most firms have been intentionally vague in their definition of who they were and how they managed money. But after 2008, clients are likely to exert pressure to resolve this ambiguity. After all, they want and deserve to know: "Who was managing my money while this happened? Was it you? Was it this other firm you hired? What were you doing while this was happening?"

Over the next three years, such questions will force competition between wealth management firms to focus primarily on first, what was the firm's approach in 2008 and how did it protect clients, and second, how will the firm manage its money to prevent the same collapse from happening again?

The problems created last year were not just a decline in asset values and questions about our assumptions about the correlation and volatility of asset classes, but even more fundamentally, they impelled clients to ask whether investing--and investment management--worked. On top of that, the collapse of Bernard Madoff's firm exposed how little clients knew about where, ultimately, their money was going. Thus we are left with an environment of skepticism about the investment management component of the wealth management service, which discourages home-grown investment strategies.

On the other hand, even we as professionals have some distrust about the service models of managers-of-managers-of-managers, thanks to the collapse of some venerable investment management institutions that appeared to be solid. Unfortunately, most firms:

A) have trouble articulating their investment philosophy and thus have trouble explaining their own results, and

B) outsource investment management and are now unsure whether they should try to answer their clients' questions or wait for the investment managers they use to do so.

The answer will likely be rooted in the same word that has dominated the industry for the longest time--"TRUST:" Who can you trust? Whoever and whatever strategy restores trust the fastest will be the winner.

From a purely strategic perspective, it seems to me that the possible responses are:

? We have our own investment managers. Many wealth management firms, especially large ones, will choose to invest more heavily in their own investment management departments or acquire one. After all, in a world where you can't trust anyone, at least you can trust yourself. Such a move would be a complete reversal of what was happening between 2005 and 2007 when firms were divesting their investment capabilities in favor of open architecture and lack of conflict. The appeal of such a strategy to clients is obvious: Clients have a greater sense of security and comfort when they can see who is managing their money and talk to that individual. However this approach is quite expensive; the cost of a full-blown investment department quickly reaches half a million dollars just by covering the basics.

By the way, even those who reject the notion of internal management--particularly active management--would admit that there is some efficiency in separate account management and a high level of communication between wealth managers and portfolio managers.
? The alliances. A less expensive alternative to having your own department is creating alliances with a few select firms that can articulate a meaningful investment philosophy and create a similar level of trust. This is a solution that many smaller firms will espouse and it has the potential to be quite successful. The risk is in the choice, since this path puts the wealth manager much closer to the investment manager, and thus it will be very difficult to disentangle from the result.

Some broker/dealers are likely to propose or create such alliances for their advisors. While contrary to the notion of open architecture, the idea seems a lot more appealing today than it did just 12 months ago.

? The passive route. Passive strategies are particularly complicated since most clients (and even advisors) confuse passive with low volatility. Clients who were steered into passive strategies usually had the notion that they were not aiming for high returns, but would not suffer a collapse of dot-com proportion because they were well diversified. For many such investors, this is proving hard to explain.

At the same time however, passive strategies gain a lot of supporters and strategic advantages from their low investment costs and the spectacular collapses of Madoff and his ilk--not to mention private equity firms. Moreover, at least most clients in passive strategies did not believe that their advisor was somehow capable of beating the market. They can see what the S&P did, and they understand that they did no better. The result may be tough to swallow, but the level of disappointment may be the lowest.

? The conservatives. Last year was particularly uncomfortable for wealth management firms that had presented clients with a more conservative profile--many of whom were outsourcing investment management, but still taking some degree of credit for the performance of portfolios. After all, the rise of the wealth management industry was due in some measure to the corporate collapses of 2001 and 2002, and came as a solution for the massive declines brought on by that recession. Still, it was always difficult for wealth managers to resist talking about the performance they had achieved from 2004 through 2007.

After, the 2001-2002 crash, many firms emphasized their conservative approach as a value proposition to clients who had considerable losses. Conservativism in 2003 meant S&P 500 stocks and wealth management firms were successful in emphasizing that philosophy. In 2009 and 2010 we will see many firms take that stance again and create large government bond and even cash positions in their portfolio as a means of emphasizing to wary clients that 35% losses in a year will never happen again.

The strategy is straightforward and has worked in the past, but it is a strategy that fits only particular types of firms--particularly firms with a lot of gray hair, with clients with a lot of gray hair and some history of conservatism.

? What doesn't kill us... Every firm will have to make some changes to its investment model in 2009, whether it means adjusting allocations to different asset classes, retooling with different correlation coefficients or standard deviation assumptions, or manually overriding some of the models for extra conservatism. Each firm will have to show a response; most firms will take the approach of changing some inputs into the model rather than the model itself.

Just as most people remember where they were on New Year's Eve 2000 or when Armstrong landed on the moon, most firms will carry in their institutional memory what they did in 2008. That crisis will define much of the market positioning in the next five years. At the end of the day it will all come down to creating and maintaining trust. Wealth management is a relationship-based business. We have to remember that what we tell clients today is hopefully something we can explain five years from now. What they are asking us about now is probably prompted by what we told them five years ago. In looking for the answer to who they are, most firms should probably stick with who they really are.

Philip Palaveev is President of Fusion Advisor Network. He can be reached at

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