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Private Wealth Management - December 17, 2008

Reactions to an EDHEC Study on Asset-Liability Management Decisions in Private Wealth Management

A revisited version of this paper was published in the Journal of Wealth Management, Winter 2009.

With the great economic growth of the past decade, private wealth management has become a very profitable business for banks worldwide. As a result, more and more asset management firms have jumped into the fray and competition has increased steadily. These industry changes have led to renewed attempts to improve client relationships and to develop tools and methods to enhance advisor effectiveness. Catering to the client’s specific needs is thus a central concern of private wealth managers. To take the client objectives into account, investments are frequently adapted to the client’s risk aversion, tax situation, and investment horizon.

The specific requirements of portfolio decisions in private wealth management have recently been examined in great detail by academic financial economists. Campbell (2006) argues that the development of optimal decision-making models for private households “is challenging because households face a number of constraints not captured by textbook models”. Campbell (2006) lists a long planning horizon, substantial holdings in non-tradable or illiquid assets, taxation, and borrowing constraints as key ingredients that put private investment decisions at odds with the assumptions in most academic asset allocation models.

Interestingly, there are tools and methods in institutional asset management that have been designed precisely to incorporate the specific constraints and objectives of long-term investors. Many pension funds or insurance companies adapt their portfolio management processes to deal with the presence of future financial objectives or constraints. Although widely used by institutional investors and their asset managers, this approach to money management is not often used in private wealth management.

A recent publication from the EDHEC Risk and Asset Management Research Centre assessed the potential benefits of using ALM techniques in private wealth management. The bottom line of the study is that the presence of specific financial objectives significantly changes the composition of the optimal portfolio, and that taking these constraints into account with suitable ALM techniques leads to significant reductions in shortfall risk.

The objective of the present paper is to compare the conclusions drawn by the paper and current industry perceptions. The question we pose is: what do practitioners think about using ALM in private wealth management? For an idea about private bankers’ view of the potential benefits of ALM, we called for reactions from private bankers and asset managers. This study not only describes these reactions, but also provides a short review of the fundamental idea of making ALM a part of private wealth management.

ALM in private wealth management appeals to most practitioners, as reactions show, but there are still concerns about successful implementation, or about the idea of transferring the rather industrial ALM techniques to the private wealth management sector as such.