EDHEC research suggests that the traditional approach to private wealth management is misguided

The results of a new study by EDHEC-Risk suggest that suitable extensions of portfolio optimisation techniques used by institutional investors can be transposed to private wealth management.

Entitled Asset-Liability Management in Private Wealth Management, by Noël Amenc, Lionel Martellini, Vincent Milhau and Volker Ziemann, this study suggest that suitable extensions of portfolio optimisation techniques used by institutional investors can be transposed to private wealth management, precisely because these techniques have been engineered to incorporate in the portfolio construction process an investor's specific context, objectives, and horizon.

The EDHEC-Risk analysis has great potential implications for the wealth management industry. Most private bankers actually implicitly promote an ALM approach to wealth management. In particular, they claim to account for the investor's goals and constraints. The technical tools involved, however, are often inappropriate and do not give the clients any insight on the risk related to reaching their objectives.

According to EDHEC-Risk, while the private client is routinely asked all kinds of questions about his current situation, goals, preferences, constraints, etc., the resulting service and product offering mostly boil down to a rather basic classification in terms of risk profiles with no link to the recommendation. In this new paper, EDHEC provide a formal framework suggesting that asset-liability management can ensure that private wealth managers are able to offer their clients investment programmes and asset allocation advice that improve the probability of meeting their individual objectives.

Broadly speaking, the EDHEC analysis shows that taking an ALM approach to private wealth management generates two main benefits:

1. First, it has a direct impact on the selection of asset classes. In particular, it leads to a focus on the liability-hedging and goal-specific properties of various asset classes, a focus that would, by definition, be absent from an asset-only perspective.

2. Second, it leads to defining risk and return in relative rather than absolute terms, with the liability portfolio used as a benchmark or numeraire. This is a critical improvement on asset-only asset allocation models, which fail to recognise that changes to asset values must be analysed in comparison to changes in liability values. In other words, private investors are not seeking terminal wealth per se so much as they are seeking terminal wealth whose purchasing power enables them to achieve such goals as preparing for retirement or buying property.

This study was produced by EDHEC-Risk as part of the ORTEC Finance Private ALM' research chair.

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