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Wealth Management - March 19, 2007

Asset-Liability Management Decisions in Private Banking

Working from the observation that the contribution of asset-liability management techniques developed for institutional investors is not yet familiar within private banking, a new study from the EDHEC Risk and Asset Management Research Centre, entitled “Asset-Liability Management Decisions in Private Banking” shows the expected benefits of a transposition of that kind.

According to the authors of the study, Noël Amenc, Lionel Martellini and Volker Ziemann, asset-liability management represents a genuine means of adding value to private banking that has not been sufficiently explored to date. Within the framework of private financial management offerings, personal wealth managers tend to confine their clients to mandates that are only differentiated through their level of volatility, without the client’s personal wealth constraints and objectives being genuinely taken into account in order to determine the overall strategic asset allocation. In that sense, private wealth management is not sufficiently different from the management of a diversified or profiled mutual fund.

It is not so much the risk-adjusted performance of a fund or even of a given asset class that is the determining factor in including it in the client’s personal wealth, but its capacity to match the client’s liabilities. The clients’ liability constraints (horizon, nature, amount and certainty of future cash flows that will be received and invested; their projects, which could have varying exposures to risk factors, whether it involves real estate or inflation) must be taken into account in managing their assets; which private bankers rarely do when they put together their clients’ overall strategic asset allocation.

In the end, it is not so much the short-term risk represented by the volatility of the assets that is the determining element in taking an individual’s risk aversion into account, but the probability or the expectation of the individual’s long-term financial objectives not being achieved.

Taking these elements into account leads to asset allocations that are very different from the allocation provided by an optimisation carried out in a static mean-variance or mean-VaR framework, as performed by the vast majority of private wealth managers.

This study was sponsored by Pictet & Cie.