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Wealth Management Models in India

By

Riddhi Mody

Student ID: 4056306

A Dissertation submitted in partial

fulfillment of the requirements for the Degree

of Masters in Finance and Investment at the

University of Nottingham

September 2007.

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ACKNOWLEDGEMENTS

I would like to thank my supervisor, Ms Alyson McLintock, for her invaluable support

and guidance throughout this dissertation. I am grateful to her for taking out time to

respond to my emails and helping me decide the framework of the dissertation.

Without her help, this research would not have been possible.

I would also like to thank Mr. Vodhisatta Chakravartty, Associate Vice President at

Kotak Wealth Management; Poonam Kataria, Citigold Relationship Manager at

Citibank Wealth Management; V.Sunithaa, Associate Vice President at Motilal Oswal

Wealth Management; and Raman Grover, Investment Advisor at Standard Chartered

Investment Services for taking out time to answer my questions and giving me a

detailed significant insight into the wealth management procedures at the respective

banks.

In the end, I would like to thank my parents and my brother for their never ending

support and encouragement and having faith in me throughout this dissertation.

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ABSTRACT

High performance levels and accelerating economic indicators worldwide has led to

an increase in the number of high net worth individuals (HNWIs) and the amount of

wealth they hold in recent years. After the economic reforms of 1991, the Indian

economy has opened up gradually and there has been an increase in the inflow of

foreign funds. As a result, investors in India and worldwide are worried about

managing their wealth and looking at alternative ways to maintaining and creating

wealth. Wealth management is defined as taking care of the needs of the affluent

clients, their families and their businesses as part of a long term, consultative

relationship. It is best conceptualized as a platform where a number of different sets

of services and products are provided. It is a full service model that offers advice on

investment management, estate planning, retirement, tax, asset protection, and

cash flow and debt protection. This study draws comparisons between the wealth

management models of four Indian companies and develops a comprehensive model

based on the above four models. This study proves that the wealth management

models used today are a combination of the Modern Portfolio Theory (MPT) and

behavioural finance theory, hence bringing about a shift from the traditional models

to a customer centric and needs based approach.

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TABLE OF CONTENTS

1 CHAPTER ONE: INTRODUCTION

1.1 Background of the Research Topic…………………………………………………………….………7

1.2 State of the World Wealth………………………………………………………………………….………9

1.3 The Indian Scenario……………………………………………………………..………………….……..10

1.4 Research Motivation…………………………………………………………………………………..…….11

1.5 Outline of the Study…………………………………………………………………………….…….…….12

2 CHAPTER TWO: LITERATURE REVIEW

2.1 A Changing Reality………………………………………………………………………………………....14

2.2 A Gap Between Theory and Practice……………………………………………………………….15

2.3 Personal Risk Matters, Not Just Market Risk……………………………………………….….16

2.4 Aspirational Risk………………………………………………………………………………………….…..18

2.5 Limitations of the Modern Portfolio Theory………………………………………………….…20

2.6 Behavioural Finance……………………………………………………………………………….……….21

2.7 Asset Allocation………………………………………………………………………………………….……24

2.7.1 Asset Allocation Strategies…………………………………………………………….……25

2.7.2 Four Fundamental Goals………………………………………………………………….….29

2.8 Risk Profiling……………………………………………………………………………………………….…..31

2.9 Risk Allocation………………………………………………………………………………………………...32

2.10The Wealth Allocation Framework………………………………………………………………..35

2.10.1 Classification of Assets………………………………………………………………….……36

2.10.2 Benchmarks…………………………………………………………………………………….….37

2.10.3 Implementation of The New Framework…………………………………………..39

2.11 Market Timings and Business Cycle……………………………………………………….…..40

2.12 Changing Business Model……………………………………………………………………….…..42

3 CHAPTER THREE: DATA COLLECTION AND METHODOLOGY

3.1 Sample Selection………………………………………………………………………………………………44

3.2 Data Collection Methodology……………………………………………………………………………45

3.2.1 Qualitative Interviews………………………………………………………………………….45

3.2.2 Advantages and Challenges of Qualitative Interviews………………..………46

3.3 Data Description……………………………………………………………………………………………….47

3.3.1 Questionnaire……………………………………………………………………………………....48

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3.3.2 Purpose of Research……………………………………………………………………………..48

4 CHAPTER FOUR: ASSET CLASSES

4.1 Equities……………………………………………………………………………………………………………..50

4.2 Bonds………………………………………………………………………………………………………………..51

4.3 Cash………………………………………………………………………………………………………………….52

4.4 Mutual Funds………………………………………………………………………………………………..….53

4.5 Real Estate……………………………………………………………………………………………………….54

4.6 Commodities…………………………………………………………………………………………………….54

4.7 Alternative Investments in Portfolios………………………………………………………………55

4.8 Investments of Passion……………………………………………………………………………………56

5 CHAPTER FIVE: FINDINGS

5.1 Kotak Wealth Management Model…………………………………………………………………..58

5.1.1 Customer Segmentation……………………………….…………………………………..…58

5.1.2 Wealth Management Process…………………………….………………………………..59

5.1.3 Asset Allocation…………………………………………………………………………………….60

5.1.4 Product Offerings………………………………………………………………………………….62

5.1.5 Mutual Fund Recommendation Process……………………………………………….63

5.1.6 Portfolio Review………………………………………………………………………………….…64

5.2 Citibank Wealth Management Model………………………………………………….……………65

5.2.1 Customer Segmentation……………………………………….………………………………65

5.2.2 Wealth Management Process……………………………………………………………….66

5.2.2.1 Citichoice…………………………………………………………………………………..67

5.2.3 Risk profiling and Asset Allocation…………………………………….…………………67

5.2.4 Product Offerings………………………………………………………………………………….69

5.2.5 Product Ratings…………………………………………………………………………………….70

5.2.5.1 Rating Process……………………………………………………………………….….70

5.2.6 Portfolio Review…………………………………..……………..……………………………….71

5.3 Motilal Oswal Wealth Management Model……………………..……………………………….71

5.3.1 Customer Segmentation………………………………………………………………….…..71

5.3.2 Wealth Management Process…………………………………………………………….…72

5.3.3 Risk profiling and Asset Allocation………………………………….……………….….73

5.3.4 Product Selection…………………………………………………………………………….……74

5.3.5 Portfolio Review……………………………………………………………………………….…..74

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5.4 Standard Chartered Wealth Management Model…………………….…………………….75

5.4.1 Customer Segmentation……………………………………………………………………..75

5.4.2 Wealth Management Process………………………………………………………………76

5.4.3 Risk Profiling and Asset Allocation………………………………………………………77

5.4.4 Product Selection………………………………………………………………………………..78

5.4.5 Portfolio Review…………………………………………………………………………………..79

6 CHAPTER SIX: ANALYSIS AND CONCLUSION

6.1 Comparative Analysis of Wealth Management Models…………………………………..80

6.2 Comprehensive Wealth Management Model…………………………………………………..85

6.2.1 Customer Segmentation…………………………………………………………………….…85

6.2.2 Wealth Management Process……………………………………………………………….86

6.2.3 Risk Profiling and Asset Allocation……………………………………………………….87

6.2.4 Products Offered…………………………………………………………………………………..88

6.2.5 Portfolio Review and Rebalancing…………………………………………………………89

6.3 Conclusion………………………………………………………………………………………………………..92

6.3.1 Wealth Management Proposition/Recommendations………………………….94

6.4 Limitations of Research…………………………………………………………….…………………….94

7 BIBLIOGRAPHY………………………………………………………………………………………………………96

8 APPENDICES..........................................................................................100

8.1 Appendix 1: Citibank Risk Profiling Form………………………………………………….….100

8.2 Appendix 2: Standard Chartered Score Based Questionnaire………………………102

8.3 Appendix 3: Standard Chartered Customer Suitability Form………….…………..105

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CHAPTER ONE: INTRODUCTION

1.1 BACKGROUND OF THE RESEARCH TOPIC

Koreto (2004a) defines wealth management as “taking care of the needs of the

affluent clients, their families and their businesses as part of a long term,

consultative relationship. It is best conceptualized as a platform where a number of

different sets of services and products are provided. It is a full service model that

offers advice on investment management, estate planning, retirement, tax, asset

protection, and cash flow and debt protection.”

Hence wealth management is a comprehensive service model to optimize, protect

and manage the well being of an individual, family or corporation. It is the next step

in financial planning. It poses a challenge for the advisors in terms of combining all

facets of a client’s financial life into a single umbrella right from estate planning to

insurance. The approach, components and intricacies however vary from each

advisor in this area.

The role of the wealth manager can be defined as four fold. It involves mobilizing the

client’s financial resources effectively to achieve financial goals, helping achieve

financial freedom, preserving the client’s wealthy state and ultimately enhancing this

state. 1

Client goals are the focus of the wealth manager. While any professional money

manager does not know details of the client’s life, goals and preferences, the process

of wealth management is founded on the values of the client first. The wealth

manager needs all the background information about the client’s fiscal life as well as

1 Dun & Bradstreet Wealth Management Seminar, 2007.

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detailed information about his goals, preferences, needs and fears. Hence, the

practice of wealth management is often termed as holistic. [Koreto, (2004b)]

The Fidelity Investments Report (2005) describes the following three fold criteria to

distinguish a firm as a wealth manager; the relationship that the wealth managers

have with their clients, the specific products and services that wealth managers

provide to clients, and the specific goals and objectives of wealthy clients as

important components in differentiating wealth management from other practice

models.

Wealth management is described as an ongoing process. It involves keeping track of

the client’s needs and goals to construct a portfolio for the client and constantly

monitoring and reviewing the performance of the portfolio and investments therein.1

The basic steps include:

• Determining client needs

• Building an investment plan

• Asset allocation based on client goals

• Ongoing review of portfolio

A special report in the Financial Times by Larsen (2007), states that “the private

banking business is on a roll.” Five years of strong markets and economic growth

and accelerating globalization has now geared this industry to be one of the hottest

growth areas.

Clients today are taking an increasingly broader view of their portfolios and are

looking to invest in sophisticated investment avenues such as real estate, hedge

funds, private equity and structured products. Hence, looking ahead wealth

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management is proving to be far more difficult than it looks on the surface involving

an in depth understanding of what actually matters to wealthy people. Wealth

managers now have the opportunity to prove themselves to clients in a way that

they had never before [Larsen, (2007)].

1.2 STATE OF THE WORLD WEALTH

The year 2006 marked a year of high performance levels owing to accelerating

economic indicators and High Net Worth Individual (HNWI)2 population expansion.

The two key drivers of wealth generation – real GDP 3 and market capitalization

increased during the year thereby increasing the number of HNWIs and their

respective wealth (World Wealth Report [2007]).

Figure 1: HNWI population, 2004-2006 (by region)

Source: World Wealth Report, 2007, by Capgemini and Merrill Lynch, p. 5.

2 HNWI is a term used in Private Banking indicating High Net Worth Individuals. Typically these individuals have investable assets (financial assets not including real estate) of 1 million USD. Source: http://investordictionary.com/definition/hnwi.aspx 3 The number reached by valuing all the productive activity within the country at a specific year's prices. Source: http://www.investorwords.com/5949/real_GDP.html

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As can be seen from figure one, the global HNWI population grew by 8.3% in the

year 2006 to touch a total of 9.5 million households. HNWI population growth was

the strongest in Africa, Middle East and Latin America posting growth rates of 12.5%,

11.9% and 10.2% respectively, as depicted in the figure above. Global wealth also

continued to increase in 2006, recording a growth rate of 11.4% over the previous

year owing to the high flourishing prices in the oil and metals industry.

Globally, GDP growth increased due to strong performance in the Asia – Pacific and

Eastern European regions. Emerging markets such as China and India outperformed

the rest of the world in 2006 sustaining Real GDP growth rates of 10.5% and 8.8%

respectively, which had a favourable effect on wealth creation. Strong corporate

profits, IPO activity and ongoing foreign investments led to rapid growth of market

capitalizations in Europe, Asia Pacific and Latin America. Rising oil revenues and

commodity prices accelerated economic growth thereby providing opportunities for

HNWIs in these regions [World Wealth Report, (2007)].

1.3 THE INDIAN SCENARIO

Taking a line from Shakespeare’s, Julius Caesar;

“There is a tide in the affairs of men, which taken at the flood leads on to fortune”,

we will witness how demographic India is now witnessing just that tide which leads

on to fortune for investors.

The economy in India is at a very sweet spot. The engines of growth such as

infrastructure, consumption, outsourcing and agriculture are making the 1 trillion

nation advance rapidly at 9% p.a. Investments in infrastructure are estimated to be

$50 billion per year for the next five years. Outsourcing from IT and auto

components are expected to contribute another $30 billion per year to this growth.

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Increasing private participation in agriculture inducing large supply chain expansions

and growth in farm and income logistics has accelerated the growth rate for the

agricultural sector to over 4% this year from the previous 2.7%. This growth rate

translates into additional wealth being created for the Indian economy [Communiqué,

(2007)].

The Indian economy’s growth rate has advanced rapidly since 1991, after economic

reforms were initiated. The progressive opening of the economy to international

trade and investment after the reforms in 1991 lowered trade barriers and helped

boost exports. India is now the global arena for increased foreign investment – both

foreign institutional investment (FII) and foreign direct investment (FDI).

[Investments Commission Report, (2005)].

India has 100,000 HNWIs with each having at least $1 million worth of financial

assets. These numbers have increased the aspiration level of many individuals who

wish to create wealth and stay rich. Sociologists feel that the aspiration level of an

average Indian has moved up manifold. Sociologist Dr. Satish Deshpande argues:

“We need to redefine India’s middle class. I feel many of our so called middle class

people have moved up to the rich category.” [Dhall and Tiwari, (2007), p.12] Hence,

there has been a wealth explosion along with an increase in the HNWI population in

the economy, which requires disciplined and focused expertise in the area of wealth

management.

1.4 RESEARCH MOTIVATION

Keeping in mind the above illustrated world wealth and Indian wealth scenario, a

new league of wealthy individuals is growing around the world and there is increased

competition amongst private bankers to supply sophisticated investment advice

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[McCrary, (2000)]. The Chinese have a saying; “Fu Bu Guo San Dai” or “Wealth

never survives three generations” [The Economist, (2001)]. This statement holds

true today and the wealthy are looking for alternative ways to retain and manage

their wealth.

As people are getting richer and richer, the task of managing and holding their

wealth gets increasingly difficult and hence the need for sophisticated wealth

management. With increasing global players penetrating the Indian market such as

Citibank, HSBC, UBS, and Standard Chartered and so on, wealth management has

taken a new dimension and private banks are now scrambling to provide an

expertise in this area.

In this backdrop, this dissertation attempts to understand the rationale behind

constructing portfolios in the wealth allocation framework, different asset classes

used while constructing portfolios, the wealth management models employed by

Kotak bank, Citibank, Standard Chartered and Motilal Oswal and a comprehensive

wealth allocation model that can be employed by private bankers in today’s

competitive arena.

1.5 AN OUTLINE OF THE STUDY

This dissertation is divided into six chapters. Chapter one provides a general

overview into wealth management and the reasons behind the research. Chapter two

discusses the two contrasting methods of constructing portfolios, one based on the

Markowitz efficiency theory and the second based on the behavioural finance theory

based on past literature review. Chapter three talks about the methodology

employed in the research and a description of the data collected. Chapter four

discusses the various asset classes used in portfolio construction. Chapter five

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discusses the wealth management models employed by four companies namely,

Kotak Bank, Citibank, Motilal Oswal and Standard Chartered. Finally, chapter six

draws comparisons between the four models and discusses the comprehensive

wealth allocation model built on the above four models.

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CHAPTER TWO: LITERATURE REVIEW

“Traditional finance assumes that we are rational, while behavioural finance assumes

we are normal”

- Mier Statman4

This chapter builds on the above quote to discuss the views of Harry Markowitz

(1952) in his landmark paper that laid the foundations for the Modern Portfolio

Theory in contrast to the views postulated by notable behavioural finance theorists

such as Kahneman and Tversky (1970), Statman (1999;2002) and Curtis (2004).

The chapter expands on the Markowitz framework of diversifying market risk to

include the concepts of personal risk as well as aspirational risk. In conclusion, the

wealth allocation framework as a way of meeting the investor’s needs for

diversification, protection and aspiration is discussed. This framework combines the

Modern Portfolio Theory with the work of several behavioural finance theorists who

have tried to understand and explain investor choices.

2.1 A CHANGING REALITY

Chhabra (2005) has discussed some of the major changes in the financial sector that

have recently occurred and have posed fresh challenges for individuals in terms of

managing their investments amidst a general rising level of prosperity.

Organizations have moved from defined benefit plans to defined contribution plans,

resulting in lump sums of liquid assets in contrast to stable pension incomes. This

has transferred risk from the capital markets to the individual making their well

being dependent on the correct investment of these assets. Also, constant

4 Quoted in Jean Brunel, “Revisiting the Asset Allocation Challenge Through A Behavioural Finance Lens,” Journal of Wealth Management, Fall 2003, p. 10.

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innovations in financial products and the advent of sophisticated financial

instruments such as hedge funds and structured products are now presenting

complicated risk reward opportunities to the individuals. These changes have placed

greater responsibility upon individuals to manage their financial future.

2.2 A GAP BETWEEN THEORY AND PRACTICE

Harry Markowitz (1952) outlined the Modern Portfolio Theory and the benefits of

portfolio diversification in his paper. There is an optimum way to create a portfolio by

combining different asset classes and this construction depends not only on the

market risk and return of each asset class but also on the correlations between the

different asset classes. These optimal portfolios, once mapped on a risk return plane,

result in a curve known as the Efficient Frontier. Risk and return are related by this

efficient frontier that gives the investor exactly how much return he earns for the

amount of risk he is willing to bear. Each investor can find a point on the efficient

frontier that reflects his desired combination of risk and return, thereby helping him

determine his optimum allocation between the different asset classes.

Markowitz’s theory explains the diversification of non systematic (market) risk and

involves an understanding that stocks, bonds and cash are not perfectly correlated.

Therefore, one can derive significant diversification benefits from holding the right

combination of these asset classes. This is further postulated by Chhabra (2005) who

holds that in order to achieve a truly diversified portfolio, it is necessary to diversify

within each asset class also. He explains that equity portfolios should be composed

of a large number of minimally correlated stocks and bonds should be diversified

across maturities and credit ratings.

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However, in spite of the above, there are a vast number of investors around the

world who are not well diversified. As Zweig (1998) suggests, it’s easier to talk about

building a diversified portfolio than to actually build one.

Although investment advisors unanimously support diversification, the advice on

implementation supplied by them is often inconsistent and in conflict with the

principles of Markowitz’s theory. As a result, investors fail to understand the true

meaning of diversification and employ several portfolio selection methods that

address only the perception of diversification than reality. [Rode, (2000)]

Rode (2000) stresses the fact that the important information provided to investors

must explain why Markowitz diversification works. Experiments carried out in his

paper demonstrated that investors did not make a clear connection between risk

reduction and diversification and hence they were unable to utilize the advice they

received on portfolio management to make effective decisions.

Rode (2000) hence states “in an environment characterized by uncertainty, where

there is considerable pressure on investors to acquire information in a form they can

quickly, correctly and consistently interpret, advice given to investors must be built

around simple strategies that produce nearly as good results as the Markowitz

optimum, rather than complicated investment strategies.”

2.3 PERSONAL RISK MATTERS, NOT JUST MARKET RISK

Markowitz’s efficient frontier approach optimizes a portfolio’s value at a single future

point in time, for example a future projected date of retirement. The idea is to invest

today so that there is enough money when approaching retirement to live

comfortably for the rest of one’s life. Although this approach may be sensible, it is

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lacking in two respects. Firstly, the investor does not know at the outset what the

specified time period will be, i.e. from the time of retirement to how long he will live

and secondly, investors need to maintain their lifestyle and meet their financial

obligations from today to the specified time period.

Figure 2: The Journey Matters

Source: Chhabra, A B (2005), “Beyond Markowitz: A Comprehensive Wealth Allocation Framework for

Individual Investors”, The Journal of Wealth Management, Spring 2005, p. 4.

All paths in Figure 2 above, lead to success but the one that dips below the client’s

minimum acceptable wealth level is a dangerous path. For instance, an overly

volatile investment strategy may sink an investor before he gets to reap its

anticipated rewards. Personal risk is thus an additional dimension that must be

accounted for in constructing appropriate portfolios for individuals. The deterministic

approach represented by the dotted line is the approach adopted by the individual to

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determine the amount of wealth he will individually need till a specified future time

period [Chhabra, (2005)].

Although, there have been several extensions of the Modern Portfolio Theory that

have tried to improve the depiction of market risks [Fabozzi et al, (2002)], the same

emphasis has not been placed on interpreting personal risk in terms of portfolio

diversification. Recent innovations in the market place as outlined in section 2.1,

should allow for the creation of portfolios that are more sensitive to individual risk

tolerances, and hence the importance of personal risk [Chhabra and Zaharoff,

(2001)].

2.4 ASPIRATIONAL RISK

Individual investors consider their success and wealth not just in absolute terms but

also relative to the standards of living they observe around them. There is a natural

urge to improve one’s well being, whether that means having more money in a bank

account, giving more away for donation or better lifestyle such as food and clothing.

For individuals, aspirational risk is therefore an important element. Among all levels

of individuals, aspirational risk taking is quite common. Every time a member of the

peer group succeeds in his/her aspirational risk taking, difficulty of remaining in the

peer group is raised for those who did not do the same. It is common to see how the

urge to maintain one’s relative standard of living can increase the pressure on the

general level of risk taking in a group of people [Chhabra, (2005)].

The three objectives of an ideal portfolio incorporate the three dimensions of risk;

personal, market and aspirational.

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1. Personal Risk: Protecting from personal risk means protecting oneself from

anxiety/poverty regarding a dramatic decrease in lifestyle. [Chhabra and

Zaharoff, (2001)].

2. Market Risk: This risk is essential to take on in order to maintain lifestyle and

standard of living and grow with the respective wealth segment.

3. Aspirational Risk: Such risk is necessary in order to break away from current

wealth segment, increase one’s wealth substantially and thereby enhance

one’s lifestyle.

The ideal portfolio therefore provides protection from anxiety/poverty (personal risk),

the ability to maintain the current standard of living (market risk) and status in

society and providing an opportunity to increase wealth (aspirational risk)

substantially or to meet aspirational goals [Chhabra, (2005)].

Figure 3: Three Dimensions of Risk

Source: Chhabra, A B (2005), ‘Beyond Markowitz: A Comprehensive Wealth Allocation Framework for

Individual Investors’, The Journal of Wealth Management, Spring 2005, p. 6

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Figure 3 above illustrates each risk dimension with its corresponding objective and

trade off. In summary, allocations to the personal risk bucket will yield below market

rates of return, the market risk bucket will yield risk adjusted market returns and the

aspirational bucket will yield higher than market returns.

2.5 LIMITATIONS OF THE MODERN PORTFOLIO THEORY

Modern Portfolio Theory operates within a set of limited assumptions5 to select an

optimal portfolio along the efficient frontier. However Curtis (2002) states that there

are several events that occur outside the Modern Portfolio Theory (MPT) for which

the theory does not provide any significant insight.

The point that Curtis makes is that although the Modern Portfolio Theory is an

essential tool in the design and management of client portfolios, advisors who rely

blindly on this theory may not be serving their clients fully. There are various events

that occur that do not fall within the principles governed by the Modern Portfolio

Theory, but are governed by very different rules and can be understood only by

reference to very different theories. MPT is only a theoretical concept that attempts

to describe how capital markets operate and hence far from perfect.

The Modern Portfolio Theory only recognizes market risk and seeks to minimize it

through diversification. It does not incorporate the dual aspects of safety and

aspiration [Lopes and Oden, (1999)]. Therefore, we need a new framework that

either replaces or builds upon the Modern Portfolio Theory. This new framework is

known as wealth allocation [Chhabra, (2005)].

5 MPT assumes continuous pricing, a world in which markets are free, societies are free and stable, minimal transaction costs and investors are rational wealth maximizers. (Curtis 2002)

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However, before going into the depths of this new framework, we will try to

understand investor behaviour through the findings of various behavioural finance

theorists. Behavioural finance runs contrary to the standard finance literature and in

the next few sections of this chapter I will attempt to explain how the psychological

preferences are embraced and incorporated into the new expanded framework of

wealth allocation.

2.6 BEHAVIOURAL FINANCE

Behavioural finance picks up where modern portfolio theory leaves off, thereby

completing the circle. The essence of behavioural finance is that it describes how

investors actually behave rather than how they should behave. The foundations of

behavioural finance were established by the work of Kahneman and Tversky, the

founders of “prospect theory”, described further on.

Kahneman and Tversky (1979) in their famous paper laid the groundwork for the

prospect theory, which attempts to understand and incorporate actual investor

behaviour. They present a critique of the expected utility theory (standard finance)

as a descriptive model of decision making. Kahneman and Tversky supported several

important factors such as certainty, probability and possibility that dominate decision

making in a risk reward setting. They asserted that people will more often prefer

lower but certain payoffs, rather than higher payoffs with less than certain

probability. This means that individuals under weigh outcomes that are merely

probable in comparison with outcomes that are obtained with certainty. This

tendency, known as the “certainty effect” leads to risk aversion whilst making

choices involving sure gains and to risk seeking in choices involving sure losses.

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Behavioural theorists Barberis and Thaler (2003) have described the direction of

behavioural research as follows: “We have now begun the job of trying to document

and understand how investors, both amateurs and professionals make their portfolio

choices. Until recently some research was notably absent from the repertoire of

financial economists, perhaps because of the mistaken belief that asset pricing can

be modeled without knowing anything about the behaviour of the agents in the

economy”.

Nevins (2004) in his article suggests that behavioural finance should play a critical

role in wealth management. Although standard finance and behavioural finance are

often seen as competing philosophies Nevins (2004) believes that there is value

addition from both the disciplines and recommend that advisors should follow an

approach to wealth management that is a blend of both the disciplines. This is in line

with the views of Curtis (2004) who speculates on the possibility of combining

rational Modern Portfolio Theory (MPT) and arrational behaviour finance process into

one advisory process, hence suggesting an iterative combination of both theories.

Curtis (2004) then suggests a three step process to design the client’s portfolio.

Step one would be to design the traditional MPT portfolio. This portfolio is based on

the forward looking view of capital market expectations and the degree of risk

necessary to grow the individual’s asset base faster than inflation, spending taxes

and so on. However, the portfolio is “uncomfortable” for the individual partly because

the portfolio may comprise of asset classes he will not fully understand and partly

because the portfolio is likely to experience periods of short term underperformance

that will test his investment patience. Step two would be designing the behavioural

finance portfolio which has the benefit of being “comfortable” for the individual and

representing a strategy that he is likely to stick with. However such a portfolio

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incorporates the individual’s inherent biases which may result in a less optimal

portfolio. Step three would be merging the two portfolios, which involves the

individual starting with a portfolio that is close to the behavioural finance model and

over time iteratively evolving toward the MPT model. By combining both MPT and

behavioural finance models, advisors stand the best chance of designing,

implementing and maintaining portfolios that prove acceptable to clients.

At a time when failed strategies have forced investors to rethink their plans for their

lifestyle and family, the investment industry needs to produce better solutions.

Nevins (2004) hence emphasizes an approach to wealth management that draws

from traditional investment theory and the newer thinking of behavioural finance,

one that closes the gap between the practitioner and advisor and helps meet the

above challenge.

Parallel to the views proposed by Curtis (2004) and Nevins (2004), Chhabra’s (2005)

wealth allocation framework, combines the Modern Portfolio Theory with the work of

several behavioural finance theorists.

The wealth allocation framework identifies three different risk dimensions namely,

personal risk, market risk and aspirational risk and seeks to address all three of

them simultaneously. It expands on the Markowitz framework of diversifying market

risk to include concepts of personal and aspirational risk as well. In the very simplest

case, this wealth allocation framework can be reduced to a standard diversified

portfolio with downside protection and enhanced upside potential [Chhabra, (2005)].

Section 1.10 builds on this wealth allocation framework. However, before going into

the implementation of the new framework, we first need to understand a few

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intricacies of wealth management such as asset allocation, risk profiling and

allocation.

2.7 ASSET ALLOCATION

For most investors, the act of investing typically begins with one stock or mutual

fund. However, as time progresses other investments are added because many

investors then realize the fallacy of having all their eggs in one basket, i.e. investing

everything in a single security.

One of the most important steps to building a successful portfolio is properly dividing

assets among different types of investments. Brinson et al (1991) for example claim

that approximately 91 percent of most portfolio returns can be attributed to the

portfolio’s asset allocation. The most important asset classes are stocks, bonds, and

cash, which are elaborated later on in chapter four. Because these investments

perform differently depending on economic conditions, a good balance among these

asset classes can keep a portfolio strong in a wide range of economic situations. In

this sense, asset allocation is the most important for diversification. Building a

successful portfolio is dependent on a number of factors and it is important to

remember that the portfolio should be constructed according to individual needs and

goals. 6

When formulating an asset allocation plan, the most important aspects to consider

are investing goals, risk tolerance, and time horizons. All three of these factors are

closely related and they allow the investor to determine how much money he will

need at certain points in his life and how much uncertainty he can tolerate while

moving from one life stage to the next. Investing goals are closely related to age and

6 www.investopedia.com

25

family situations. Younger people generally have a greater tolerance for risk in their

investments because they can afford to wait out bad periods and make up the

difference later. Long time horizons allow for riskier investments because temporary

downturns will not ruin the long-term plan. Once the time horizons and the level of

risk are decided by the investor his next step is to decide which investment options

are best for his profile.

In short, asset allocation helps determine how much of a portfolio should be invested

in each asset category and it is more of a personal process depending on each

individual. Creating a successful asset allocation strategy involves striking the right

balance between the investor’s tolerance for risk against the volatility levels of

various asset classes.

2.7.1 Asset Allocation Strategies

There are a few asset allocation strategies and outlined below are some of them as

described by Bergen (2004).

Strategic Asset Allocation

Strategic asset allocation is a method that establishes a 'base policy mix'. This is a

proportional combination of assets based on expected rates of return for each asset

class. A required rate of return is defined and asset classes are combined in various

proportions to achieve this desired rate of return. For example, if stocks have

historically returns of 20% per year and bonds have returned 10% per year, a mix of

50% stocks and 50% bonds would be expected to return 15% per year.

26

Constant Weighting Asset Allocation

Strategic asset allocation generally implies a buy-and-hold strategy, even as the shift

in the values of assets cause a movement away from the initial base policy mix. For

this reason, a constant-weighting approach to asset allocation is desired over

strategic asset allocation. With this approach, the investor constantly rebalances his

portfolio.

There are no hard-and-fast rules for the timing of portfolio rebalancing under

constant-weighting asset allocation. However, a standard rule is that the portfolio

should be rebalanced to its original mix when any given asset class moves more than

5% from its original value.

Tactical Asset Allocation

Over the long run, a strategic asset allocation strategy may seem relatively rigid.

Therefore, the investor may find it necessary to occasionally engage in short-term,

tactical deviations from the initial mix in order to take advantage of exceptional

investment opportunities. This intoduces a component of market timing to the

portfolio and allows the investor to participate in favourable economic conditions.

Tactical asset allocation can be described as a moderately active strategy, since the

overall strategic asset mix is returned to when desired short-term profits are

achieved. This strategy demands some expertise, as the individual must first be able

to spot when such short-term opportunities occur, and then rebalance the portfolio

to the long-term asset position.

27

Dynamic Asset Allocation

Another active asset allocation strategy is dynamic asset allocation, with which the

individual constantly adjusts the mix of assets as markets rise and fall and the

economy strengthens and weakens. With this strategy he sells assets that are

declining and purchase assets that are increasing, making dynamic asset

allocation the opposite of a constant-weighting strategy.

Insured Asset Allocation

Under an insured asset allocation strategy, a base portfolio value is established

below which the portfolio should not be allowed to fall. Active management is

exercised to ensure that the portfolio earns a rate of return above its base value.

However, if the portfolio value drops below the base, then it becomes necessary to

invest in risk free assets so that the base value becomes fixed.

Insured asset allocation is most suitable for risk averse investors who desire a

certain level of active management strategies but value the security that offers a

predetermined floor value, below which the portfolio value is not allowed to drop.

Integrated Asset Allocation

All of the above mentioned strategies take into account future market returns and

expectations, but fail to account for investor’s risk tolerance. With integrated asset

allocation, both economic expectations and risk tolerance is considered while

deciding an asset mix. Therefore, integrated asset allocation is a broader asset

allocation strategy incorporating aspects of all strategies and including not only

expectation but also changes in capital markets and individual risk tolerances.

28

Bergen (2004) however says that the above strategies are only general guidelines on

how investors may use asset allocation as part of their core strategies; and choosing

a single asset allocation strategy or a combination of the above is dependent on the

investor’s goals, age, market expectations and risk tolerance.

Brunel (2003) looks at asset allocation from a behavioural finance perspective. He

introduces a simple framework which is applicable across a number of different

individual circumstances and allows each investor to feel that relevant light has been

brought onto the asset allocation process.

Statman (1999) postulates that one can view a portfolio as a pyramid comprised of

several layers, each of which is meant to fulfill a distinct investment goal. Each layer

of the pyramid is associated with broad categories of investments and fulfills goals of

downside protection right from the base of the pyramid to the upside potential layer

at the top.

Figure 4: The Wealth Pyramid (US$)

Source: Global Private Banking Survey (2007), by PriceWaterhouse Coopers, p. 9.

29

In contrast to this, the global private banking survey by PriceWaterhouse Coopers

(2007) presents a wealth pyramid which segments customers into 5 different wealth

bands as depicted in Figure 4 above based on the individual’s financial asset base.

Each wealth band as depicted above has different needs and preferences and assets

are allocated accordingly.

Brunel (2003) applies a more detailed strategic asset allocation process, using it to

define the asset mix most likely to help the investor achieve his investment goals. In

this framework, rather than focusing on the suitability of each investment or strategy

to a specific pyramidal layer, the investor is invited to quantify the relative

importance of four distinct investment goals (liquidity, income, capital preservation

and growth) in his circumstances. After prioritizing and quantifying the importance of

these goals, the advisor then simply combines various sub portfolios designed to

meet each of these individual goals in the appropriate proportions.

2.7.2 Four fundamental goals

Brunel (2003) depicts the individual needs of a vast majority of investors as a

combination of the four fundamental goals described below.

Liquidity is designed to include the funds that the investor will need over some

relatively short period of time, measured in months. The implications of this goal are

that the liquidity oriented investor cannot bear any “downward volatility” that will

risk losing his principal and that all investments must be easily marketable so that

the investor will have cash in hand at any required time.

Income represents the cash flow needs of the investor required to maintain his

lifestyle. Having cash in hand for living expenses is of prime importance to the

30

income oriented investor. Depending upon each individual’s circumstances, these

needs may either be very small or very large, depending on the investor’s asset

holdings. In situations when those needs are relatively small, generation of income

may not be very important and in situations where those needs are large, generation

of income will be an important phenomenon and the investor may also have to

indulge in significant cash flow planning activities.

Capital preservation defines the needs of those investors who do not wish to bear

the risk of losing even a small portion of their capital or principal. For every capital

preservation oriented investor, it is important to keep in mind that the probability of

increasing the value of the portfolio is related to the risk of a rise or fall in the value

of the market. Such investors are generally very risk averse and they preserve

capital for important reasons such as purchasing property, children’s education and

so on and hence cannot risk losing any part of their principal. However, they face

the risk of the value of the principal eroding as time progresses.

Growth refers to a need to see the investor’s capital appreciate. An important

consideration to keep in mind here is that the capital markets are a place where

wealth is preserved and not where wealth is created in contrast to the need for

significant returns for growth oriented investors. Such investors are generally

aggressive, risk takers and are interested in creating wealth.

After defining each of these component goals, the investor then begins to allocate his

or her assets among them. The focus remains on the goals of the investor and not

on a strategic allocation benchmark as proposed by an advisor. The approach

described above can thus be categorized as influenced more by behavioural finance

than pure investment theory.

31

2.8 RISK PROFILING

Risk profiling, which is the primary link between the client and the investment

recommendation is used to establish the client’s level of risk tolerance. It is an

important step in financial planning but is sometimes poorly implemented. Two

difficulties in building an effective risk profiling process are; one that the information

people provide about their attitudes towards risk can be deceptive and tough to

interpret and second that it is not easy to combine risk tolerance estimates with

other factors affecting investment selection, such as client goals [Nevins, (2004)].

Proper risk profiling requires some form of questioning, either orally or in

questionnaire form, with most advisors employing both methods. Callan and Johnson

(2002) also suggest that risk profiling requires a scientifically developed measure of

risk tolerance, generally obtained using a questionnaire. Nevins (2004) points out

that it is vital that the questions for risk profiling should be framed carefully to gauge

the investor’s true attitudes without introducing biases into the risk profiling process.

Pompian and Longo (2004) believe that the popular methods of client profiling today

have resulted in weak investment outcomes for a large number of investors. They

suggest that many investors lack behavioural control; investors and advisors

continue to implement investment programs that consist mainly of risk tolerance

questionnaires, without incorporating other important measures such as personality

type and gender. They verify that by profiling investors by personality type and

gender, advisors can create programs that reduce individual biases by encouraging

investors to observe their long term strategies thereby saving them the costs of

rebalancing their investments in case of unexpected market movements.

32

They suggest the following four step method for advisors to consider while assessing

risk tolerance for their clients.

• Step One: Ask the client to take a personality type test.

• Step Two: Evaluate responses to determine personality type

• Step Three: Assess risk tolerance using type and gender based risk tolerance

scales, incorporating other aspects of the client’s profile into the assessment

such as the investor’s life cycle stage and other qualitative measures.

• Step Four: Execute investment program.

2.9 RISK ALLOCATION

Individuals have complex wealth profiles. They often have multiple and conflicting

goals and their portfolios include several different kinds of assets. All these factors

need to be considered simultaneously designing client portfolios. Chhabra (2005)

thus introduces the concept of risk allocation. According to him, portfolio assets as

well as appropriate risk adjusted benchmarks need to be assigned to the each of the

personal risk, market risk and aspirational risk buckets.

33

Figure 5: Dynamic Risk Allocation

Source: Chhabra, A B (2005), ‘Beyond Markowitz: A Comprehensive Wealth Allocation Framework for

Individual Investors’, The Journal of Wealth Management, Spring 2005, p. 10

The investor’s optimal risk allocation depends not only on the risk return

characteristics of the markets, but also on how much wealth an investor has relative

to what she needs and how far away from the danger zone he/she is. This is

illustrated in the Figure 5 above. It is important to note that the minimum level of

wealth as shown above will often vary based on the current wealth of the investor as

opposed to a fixed number based on the actual amount needed to maintain a

lifestyle. This is consistent with Kahneman and Tversky (1979) who observe that

gains and losses by investors are viewed in relation to a reference level.

34

Figure 6: Sample Risk Allocations

Investor Personal Risk Market Risk Aspirational Risk

Do Not Jeopardize Maintain Lifestyle Enhance Lifestyle

Basic Standard of

Living

Conservative 60% 30%-40% 0%-10%

Affluent 40% 40%-60% 0%-20%

Wealthy Small/Medium Medium/Large Medium/Large

Source: Chhabra, A B (2005), ‘Beyond Markowitz: A Comprehensive Wealth Allocation Framework for

Individual Investors’, The Journal of Wealth Management, Spring 2005, p. 20

The author points out that if an individual is in the danger zone, he should be more

conservative and should value investments that do not go down more highly. This

means the relevant risk measure is the possibility or danger of negative returns,

rather than the possibility of upside returns. As illustrated in Figure 6 above, this risk

allocation will be dominated by personal risk.

If the investor has a decent cushion from the danger zone, then his allocation is

similar to the aggregate market and the appropriate risk measure is similar or

identical to the one used by financial markets i.e. volatility. Figure 6 above depicts

that this risk allocation will be over weighted by assets in the market risk bucket.

The benefits of being in this zone are that, since one has similar risk return

characteristics as the market, one invests in liquid and low transaction cost securities

such as stock and bonds. However, Chhabra (2005) notes that as investors get

wealthier, they begin to look for avenues that allow for further upside potential. In

this region they are willing to take greater risks and bear a possible loss of principal.

This risk allocation will be over weighted by assets in the aspirational bucket as

shown in the figure above.

35

Bien and Wander (2002) introduce a risk allocation framework that focuses on risk

exposures instead of asset class exposures. They propose an integrated framework

that allows investors to integrate active management decisions into the asset

allocation process leading to greater portfolio flexibility and improved risk/return

trade offs. They further emphasize that most individuals and consultants follow the

conventional asset allocation approach which fails to incorporate the risk and returns

of the active part of the portfolio into the asset allocation decision. On the contrary,

in the integrated risk allocation framework, active risk and systematic market risk

are both part of the asset allocation process.

2.10 THE WEALTH ALLOCATION FRAMEWORK

Chhabra’s (2005) wealth allocation framework builds upon, complements and adds

several benefits to the classic asset allocation approach. The framework makes it

easier to use non traditional assets – such as alternative and structured investments,

annuities and insurance together with traditional assets, such as stocks and bonds. It

supports a long term diversified approach to investing and it allows the indivudal to

pursue and protect lifestyle and wealth level goals, in addition to investment

diversification and performance. Most importantly, it allows the individual to bring all

the aspects of his/her financial life under one simple organizing umbrella.

This section focuses on the implementation of the new framework, the first being a

methodology to classify all of the investor’s assets into the three different “risk

buckets” and the second dealing with choosing appropriate benchmarks for the

overall performance of the assets in each of these risk buckets.

36

2.10.1 Classification of assets

Under the wealth allocation framework, both the asset type and the role it plays in

the portfolio determine the placement of each asset into one of the three different

risk buckets. Therefore, as rightly pointed out by the author, the same asset can be

a part of different buckets for different individuals.

An important point illustrated by Chhabra (2005) is that under this framework, the

portfolio will often be mean variance inefficient - that is, off the efficient frontier.

However, when viewed overall it provides greater protection and upside potential

with wide range of outcomes.

Figure 7: Asset Classifications for Each Risk Bucket

Personal Risk Market Risk Aspirational Risk

Protective Assets Market Assets Aspirational Assets

• Cash • Equities • Alternative Investments

• Home Purchase • Fixed Income � Investment Real Estate

• Home Mortgage

• Cash (Reserved for Opportunistic Investments)

• Investment Concentration

• Safe Investments • Strategic Investments • Small Business • Principal Protected

Funds • Concentrated Stock and

Stock option positions • Annuities to provide

safe source of income

• Hedging

• Insurance

• Human Capital

Source: Chhabra, A B (2005), ‘Beyond Markowitz: A Comprehensive Wealth Allocation Framework for

Individual Investors’, The Journal of Wealth Management, Spring 2005, p. 11

As Figure 7 clearly illustrates, securities that provide some degree of principal

protection fall in the personal risk category. Examples are cash, short term

government backed treasury bonds, inflation indexed bonds, principal protected

37

mutual funds, annuities of certain kinds and risk management instruments and

strategies. Such instruments are a part of this category because they protect the

value of the principal and are conservative investments that help sustain the basic

standard of living. Most conventional securities fall in the market risk bucket, since

they follow the market. Alternative instruments like fund of hedge funds,

commodities etc belong to this category since they imitate the market risk return

pattern. Executive stock options, concentrated stock positions, single manager hedge

funds, leveraged investment real estate and call options are examples of investments

that fall in the aspirational risk bucket since these investments provide an

opportunity to significantly enhance capital and provide greater returns [Chhabra,

(2005)].

2.10.2 Benchmarks

Investors have very different performance expectations for the assets allocated to

each of the three risk buckets and these expectations must be benchmarked against

appropriate indices. The idea of having a different benchmark for each of the three

sections of the portfolio is important. In the first bucket, the investor pays for and

receives safety. In the third bucket, he gets a chance to earn significant returns,

accompanied however with a significant probability of loss of capital.

38

Figure 8: Performance and Risk Measurement for Each Risk Bucket

Personal Risk Market Risk Aspirational Risk

Protective Assets Market Assets Aspirational Assets

Expected Performance Expected Performance Expected Performance • Below market returns

for below market risks • Market returns and

market risks • Above market returns

and high risks

Sample Benchmarks Sample Benchmarks Sample Benchmarks

• Consumer Price Index • S&P 500 • CLEW Index

• 3 month LIBOR • Lehman Agg.Bond MSCI • Absolute Return Value

World Index

Risk Measures Risk Measures Risk Measures

• Downside Risk • Standard Deviation • Upside Return Measures

• Scenario Analysis • Sharpe Ratio • Manager Alpha

• Beta • Scenario Analysis

• Scenario Analysis

Low Risk/Return Spectrum High

Source: Chhabra, A B (2005), ‘Beyond Markowitz: A Comprehensive Wealth Allocation Framework for

Individual Investors’, The Journal of Wealth Management, Spring 2005, p. 10

As Figure 8 above depicts, we can see that assets in the personal risk bucket should

be expected to appreciate at below market rates since they are conservative

investments. Suitable benchmarks are the consumer price index or 3- month LIBOR.

Suitable risk measures could use downside risk rather than volatility. Assets in the

market risk bucket follow the standard Markowitz framework. Their performance can

be compared to a standard benchmark constructed from appropriate weighting of the

S&P 500 and an aggregate bond index. Assets in the aspirational risk bucket should

significantly outperform standard market indices. Example of such benchmarks could

be the Forbes Magazine’s Cost of Living Extremely Well Index (CLEWI), a hedge fund

index or a large alpha over a standard market index [Chhabra, (2005)].

39

2.10.3 Implementation of the wealth allocation framework

Chhabra (2005) has outlined an implementation schema for the wealth allocation

framework as depicted below:

1. Gather complete diagnostic information: This involves understanding lifecycle

details, determining client goals and priorities, assigning cash flows and

timelines to each goal and using risk questionnaires to determine client risk

factors and personal danger zone.

2. Perform risk allocation, asset allocation and portfolio construction

3. Compute probability of achieving goals using scenario analysis and Monte

Carlo simulations.

4. Readjust: risk allocation, client goals and asset allocations within each risk

bucket

5. Repeat steps one to four till success and optimum balance are achieved.

6. Check robustness of solution to market and client risk factors.

7. Implement

8. Review and readjust as needed.

This implementation schema is important and is the basic process of wealth

management followed by most private banks today. In Chhabra’s (2005) article

however, it is mentioned only in the appendix and not elaborated upon. I have

therefore looked at the wealth management process in depth in chapters five and six.

Under this wealth allocation framework, risk allocation precedes asset allocation for

the individual investor. The ultimate goal of this framework is to allow for the

optimum allocation of risk and to meet the investor’s safety and aspirational goals

while still benefiting from efficient markets. By combining Modern Portfolio Theory

and behavioural finance models, gives advisors the opportunity to design portfolios

40

that will be well accepted by clients as well as work towards generating superior

returns for them.

2.11 MARKET TIMING AND BUSINESS CYCLE

Some portfolio managers claim that market timing is also a determinant of

generating superior returns. Although several researchers agree that it is not

possible to predict market timing, Larsen and Wozniak (1995) claim that market

timers alter their asset allocation mix to reflect the “investor’s perception of their

short term relative performance.” Investors often believe that advisors and

managers can predict market movements and are “intrigued” by advisors who can

take advantage of a bull market as well as protect portfolio value in times of a bear

market. [Cooper and Cheiffe, (2004)].

Although various methods have been proposed for forecasting market timing by

researchers such as Arnott and von Germeten (1983) and Larsen and Wozniak (1995)

none of the studies have been able to provide a strategy that helps generate returns

above the normal. Cooper and Chieffe (1995) attribute this to the simple reason that

for an asset class to give higher returns a major shift in the economy is required.

Though, business cycle changes are not recognized till a much later date, they hold

that for an investor to earn abnormal returns these business cycle changes must be

recognized within one month of transition.

Wealth management supports active asset allocation and many studies in active

asset allocation measure the spread between stocks, bonds and cash against a

determined benchmark. Studies such as these by Arnott and von Germenten (1983)

and Einhorn and Shangquan (1984) conclude that active asset allocation can be

executed by closely watching the relative returns of stocks and bonds and reacting

41

accordingly. However, another study by Brinson, Hood and Beebower (1986)

contradicts these results proving that market timing does not play a significant role

in the returns of a pension fund portfolio. Clinebell, Kahl and Stevens (1991) also

conclude that using the spreads between stocks and bonds do not serve as a sound

basis for active asset allocation.

Jones (1987) adopts a business cycle approach to wealth management, while

managing client portfolios. His paper makes use of economic statistics to determine

the current phase of the business cycle.

Every industry has its own business life cycle. Ineichen’s (2004) article talks about

the three stages of the asset management industry. He puts forth the view that the

asset management industry is about to move from the second stage to the third. He

defines the first stage as a holistic one, where individuals and investors created a

single balanced portfolio of stocks, bonds and cash to generate returns. However,

lack of specialization and manager accountability generated average returns and

resulted in the industry shifting to the second stage: the relative performance game.

Under this relative return approach, passive market indexes acted as benchmarks

against which performance could be measured and investment managers were held

accountable. This second stage fit nicely with the Modern Portfolio Theory, with

market indices used as benchmarks. However, with the evolution of performance

evaluation and outperforming the benchmark being the focus of only a minority of

managers again led to low returns in the industry.

The absolute return approach, the third stage in the industry, introduces an absolute

yardstick against which managers are measured. Ineichen (2004) states that under

this approach active asset managers are hired and paid to balance investment

42

opportunities with an absolute measure of risk. Under the absolute return approach,

risk is viewed as the total risk faced by the investor and not the market risk under

the relative return approach.

2.12 CHANGING BUSINESS MODEL

The Global Private Banking Survey (2007) by PriceWaterhouse Coopers reveals a

period of unprecedented growth opportunities for wealth managers. The survey

emphasizes the move towards a more client centric approach and today, private

banks and wealth managers are moving towards this realization that the changing

business model involves not only understanding products but also client service and

their needs.

Central to this new model, is improving client overall client experience thereby

increasing client satisfaction. Segmentation also is now client centric designed to

serve clients better not shifting focus from cost savings for wealth managers. The

survey also emphasizes on the importance of capturing client feedback; wealth

managers understand the implications of putting clients at the heart of their

organizations and therefore the need to listen and respond to feedback.

The spotlight section of the World Wealth Report (2007) also focuses on client

service models and how they are changing from traditional models. As the needs of

the high net worth individuals (HNWI’s) are becoming increasingly complex, the

wealth management firms are realizing that the quality of their service models is tied

to their continued success.

Leading firms are now adopting a dynamic needs based approach to increase client

satisfaction. Taking a needs based approach allows firms to better satisfy client

43

needs, thus increasing client satisfaction, retention and acquisition. Firms are now

assessing clients using a more fluid, in depth and iterative needs based approach. In

this enhanced model, both clients and wealth management firms benefit from the

optimization of initial pairing and revaluation of client needs with firm offerings.

[World Wealth Report, (2007)].

Both the above findings are consistent with the views proposed by Lucas (2006) in

his book that talks about the transition from classic wealth management to strategic

wealth management. He emphasizes the strategic approach to wealth management

instead of the classically flawed approach, which is a holistic approach and focuses

on the client’s interests. The book explores all the strategic options while putting the

client in the driver’s seat and enabling the client to employ their advisors to the

fullest. The client’s values, skills, resources and how they relate to their family are at

the core of the strategic wealth management approach. In short, the strategic

approach requires the client to take control of the wealth management process.

As can be evidenced from the works of the different authors above, Gallagher (2004)

rightly concludes that although the wealth management industry is now undergoing

a huge change, it is at a critical juncture. As investor’s needs are changing, more

demands are placed on the role of the advisor and the key to success for advisors

will lie in their adaptability to the changing environment. Advisors will need to tailor

their services to their client’s total wealth management needs to meet their shifting

demands.

44

CHAPTER THREE: DATA COLLECTION AND METHODOLOGY

This chapter discusses the samples selected, the methodology employed in data

collection, advantages and disadvantages of the same and the data collected through

a semi structured questionnaire.

3.1 SAMPLE SELECTION

In my dissertation, I have looked at four companies namely, Kotak Bank, Citibank,

Standard Chartered Bank and Motilal Oswal. Kotak, Citibank and Standard Chartered

have an international presence and are established in the field of wealth

management. Motilal Oswal however, is a new entrant in the field of wealth

management and has only a domestic presence. Kotak and Citibank are known for

their aggressive approach in the market whereas; Standard Chartered adopts a

mellow approach to wealth management. Comparing the four companies gives an

insight into how the international approach differs from the domestic approach.

Although, the wealth management models employed by the four companies are

broadly similar, there are various intricacies in these models which differ from

company to company. Where Citibank and Standard Chartered have the most

comprehensive risk profiling system, Kotak and Motilal Oswal have the most

comprehensive asset allocation system. In terms of portfolio tracking and reviewing,

Citibank and Standard Chartered make use of sophisticated tools and mechanisms

for monitoring client portfolios. Product offerings are the widest in Kotak and

Standard Chartered. This can be attributed to the international expertise. However

inspite of these intricacies which differ from company to company, an important

similarity between all the four companies is that each of them adopts a very

customer centric attitude and offers flexible and customized solutions for their clients.

45

These four companies were selected carefully to bring out clearly the differences in

the approaches to wealth management and the wealth management models

employed.

3.2 DATA COLLECTION METHODOLOGY

In this dissertation I have employed the qualitative research methodology of data

collection. Qualitative research is mainly concerned with “why” and involves

gathering information that is varied, in depth and rich. The information relates to

how something is experienced, opinions and values rather than facts, figures and

statistical data.7

There are a variety of methods used in qualitative research. Below are a few of the

common methods: 8

• Participant observation

• Direct observation

• Unstructured interviewing

• Case studies

3.2.1 Qualitative Interviews

I have employed qualitative interviews as my research methodology. Qualitative

interviews are of various types ranging from:9

• Qualitative questions added to structured surveys and questionnaires

• Semi structured interviews

• Open ended but probing interviewing

• Open ended ad hoc conversations

7 reuma.rediris.es/omeract/docs/OMERACT%20Glossary.htm 8 http://www.socialresearchmethods.net/kb/qualmeth.php 9 http://www.enterprise-impact.org.uk/word-files/QualMethods.doc

46

Here, I have used semi structured interviews for my data collection. Semi structured

interviews comprise of various open ended questions and responses to such

questions are recorded in detail. Enough space is left for unexpected issues to arise

in the course of the interview. Qualitative interviews involve continuous probing and

cross checking of information. Good interpersonal skills and careful documentation

are crucial features of qualitative interviews. 14

3.2.2 Advantages and Challenges of Qualitative Interviews

The very essence of a qualitative interview is its openness and flexibility which

creates a variety of opportunities for the researcher [Botha, (2001)]. The researcher

works directly with the respondent and hence it is a far more personal method. The

researcher also has an opportunity to probe and gain further information into the

area of interest. It also helps clarify or explain questions, increasing the likelihood of

gathering correct information. It therefore helps gather rich data, explore topics in

depth and gain new insights. Qualitative interviews are easier for the participants too

since opinions and impressions are sought for. 10 The participants can express

themselves freely in their own words rather than being restricted to predetermined

categories and hence they feel more relaxed and are more candid. This method

hence provides high credibility and face validity.11

Qualitative interviews are however very time consuming and expensive. The

interviewer requires considerable expertise in human interaction and must be trained

to respond to any contingency. There is therefore a need for well qualified and highly

trained interviewers [Botha, (2001)]. Also, a lack of a structure, excessive openness

and flexibility can lead to inconsistencies across interviews. The participants may

10 http://www.public.asu.edu/~kroel/www500/Interview%20Fri.pdf

11 http://ag.arizona.edu/fcs/cyfernet/cyfar/Intervu5.htm

47

distort information based on selective perceptions and desire to please the

researcher. The participant’s moods and personality must also be taken into account.

Data gathering, analyzing and interpreting qualitative interviews is also very time

consuming. The volume of information may be large and it is difficult to interpret and

evaluate such large masses of data.12

The data regarding the wealth management practices in the four companies was

collected by interviewing people from the respective companies. Employees from the

wealth management or private banking divisions were interviewed. After taking prior

appointments with the companies, direct interviews were held with the concerned

employees. A series of open ended questions were asked, the answers to which were

recorded in detail. Issues other than those pertaining to the questionnaire were also

discussed to gain further insight. The people interviewed included Mr. Vodhisatta

Chakravartty, Associate Vice President at Kotak Wealth Management; Poonam

Kataria, Citigold Relationship Manager at Citibank Wealth Management; V.Sunithaa,

Associate Vice President at Motilal Oswal Wealth Management; and Raman Grover,

Investment Advisor at Standard Chartered Investment Services.

3.3 DATA DESCRIPTION

The data in this dissertation pertains to the wealth management practices and

models followed by the four companies. A varied amount of data was collected which

included, the various types of customers who can avail wealth management services

and the minimum investment limits, if required, the basic process of wealth

management followed by each company, the risk profiling and know your customer

(KYC) systems followed, the asset allocation models used while determining the

client’s investment ratios and whether they are flexible or standardized, the different

12 http://www.ehr.nsf.gov/EHR/REC/pubs/NSF97-153/CHAP_3.HTM

48

product offerings and asset classes used while constructing the client’s portfolio, how

these products are selected and the fund house rating process and finally the

procedure for updating clients and reviewing and monitoring portfolios.

3.3.1 Questionnaire

In order to collect the data described above, an open ended questionnaire was

formulated which is listed below:

1. What are the different kinds of customers for the company?

2. Are there minimum investment limits for these different kinds of customers?

3. What are the different asset classes used by the company?

4. What are the steps used in the wealth management procedure?

5. How is the profiling of customers done and how are the different profiles

ranked?

6. How the assets allocated to different clients?

7. What are the different products offered to the customers?

8. How are these different products e.g. insurance, equity, debt chosen?

9. Who does the research for the company?

10. How are the portfolios reviewed and investors updated?

3.3.2 Purpose of research

In this dissertation I have attempted to understand the wealth management models

and intricacies followed by four companies and then draw comparisons between all of

them. After comparing the four models, I have formulated a comprehensive wealth

management model based on the insights drawn from the four models. This model

builds on the weaknesses and incorporates the strengths of the four models studied

and hence will prove to be a robust and effective model. This study aims to highlight

49

how companies are now using behavioural finance theory as well as the efficient

market prognosis in their approach to wealth management, thus staging a revolution

from traditional wealth management models to dynamic client centric models.

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CHAPTER FOUR: ASSET CLASSES

This chapter briefly explains a few, commonly used asset classes while constructing a

client portfolio by investment advisors.

An asset class is simply a category of an asset. Each asset class has different

qualities and strengths. Getting to know their risk reward characteristics helps

advisors work out a suitable strategy for the investors.13

The most popular and traditional asset classes are cash, bonds and shares but many

more assets are also considered in an investment portfolio. These range from

commodities, art, structured products to even classic cars and fine wines. These are

also termed as alternative investments [Guide to Asset Classes, (2007)].

4.1 EQUITIES14

Equities also known as stocks or shares represent an ownership in the company and

a share in the company’s assets through the share price. Equities can provide a

source of income for investors, because they get a share in the company’s profits

through dividend payments. Dividends, although not guaranteed are paid out of the

company’s profits, normally twice a year.

Investors can also earn or lose money based on increasing or decreasing share value.

Stock prices rise when the company grows and the demand for its shares rise and

vice versa. A common idea is to buy the stock when the company is small, hold on it

for a number of years while the company grows and then sell it for a profit when the

company is doing well. Stocks however are most volatile in the short term. Although

13 http://www.fidelitypensions.co.uk/planning_for_retirement/asset_classes.html 14 http://www.msmoney.com/seminars/seminar1/html/step4/different_asset_classes1.htm

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over long periods of time they offer the potential of significant growth, their value

can go up or down dramatically over a short period of time, making them the riskiest

asset class. An important point to note is that returns and the principal value of the

investment fluctuates, and when the shares are redeemed they may be worth more

or less than the original investment. 19

4.2 BONDS

Bonds are a conservative and guaranteed form of investment. They represent loans

to a government or a company for a set period of time. They offer a predetermined

rate of return and repayment of original investment on a set date, known as the

redemption date or the date of maturity. Bonds are alternatively known as fixed

income investments because they make regular interest payments until the date of

maturity. 15

Bonds from a company are known as corporate bonds and bonds from a government

are known as government bonds. Government bonds offer the greatest degree of

security since they are backed by the full faith and credit of the government.16

Bonds are a good way of making income from savings because they offer higher rate

of returns than banks and are more stable than equities. They are however, riskier

than cash because the company issuing the bonds may default in interest payments.

In general, the longer the bond’s maturity, the more its price will be affected by

fluctuating interest rates. To compensate for this, long term bonds offer higher

interest rates than short term bonds. 17

15 http://www.msmoney.com/seminars/seminar1/html/step4/different_asset_classes1.htm 16 https://my.axa.co.uk/genesys/aslimpweb?context=displayPage&content=inv-how-assets-fixedinterest&path=page 17 http://www.fidelitypensions.co.uk/planning_for_retirement/asset_classes.html

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4.3 CASH

Cash as an asset class refers to money that is invested in banks, building societies

and other organizations to produce interest. Although it does not offer the best

potential return, it is the least risky asset class. Cash and cash equivalents are safe,

short term, very liquid investments. They serve as excellent savings vehicles for

short term goals. 18

Treasury bills, certificate of deposits (CD’s) and other short term securities are

known as cash and cash equivalents. They earn money through interest, which is

generally a predetermined rate of interest. This rate of interest must always exceed

inflation to help maintain the purchasing power of money. 19

Figure 9: Risk Vs Return of Cash, Bonds and Shares

Source: Guide to Asset Classes (2007), By Insight Investment, p. 10.

18 https://my.axa.co.uk/genesys/aslimpweb?context=displayPage&content=inv-how-assets-cash&path=page 19 http://www.fidelitypensions.co.uk/planning_for_retirement/asset_classes.html

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Figure 9 above shows the risk reward characteristics of the three basic asset classes.

Where cash and bonds have relatively low risk reward characteristics, shares are the

most volatile offering the greatest returns coupled with high risk.

4.4 MUTUAL FUNDS

A mutual fund is managed by an investment company, where investments are held

by a large number of people and the company invests that money in a selection of

various assets. Investors pool their money together and entrust it to a professional

money manager who buys and sells securities based on the fund’s objective. The

shares of a mutual fund are purchased and redeemed upon demand, based on the

fund’s net asset value. 20

Each fund has a predetermined objective such as, a predetermined rate of return to

be achieved, that tailors the fund’s investments. Also, each fund has different risk

and reward characteristics. The higher the potential return, the higher is the risk of

loss. 21

The greatest advantage of investing in a mutual fund is that it is inherently

diversified; holding shares in a great number of securities. The investor also receives

professional money management and expertise, which would otherwise be costly to

avail. 22

20 http://www.fidelitypensions.co.uk/planning_for_retirement/asset_classes.html 21 http://www.investopedia.com/university/mutualfunds/mutualfunds1.asp 22 http://www.msmoney.com/seminars/seminar1/html/step4/different_asset_classes1.htm

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4.5 REAL ESTATE23

Real estate as an investment class usually means investing in commercial property

such as offices, retail developments, leisure and industrial developments. Real estate

returns can run counter to conventional investments such as stocks and bonds and

hence are helpful in diversifying the investor’s portfolio. A major attraction of

investing in this sector is that the success of the venture depends on professional

property management; successful maintenance and repairs can add value to the

capital value of the property.

However, the value of the property is not guaranteed and can rise or fall depending

on market conditions. The investor can get back less or more than the value of the

original investment. The real estate sector is subject to various risks such as

movements in property prices and environmental liabilities such as floods,

earthquakes and so on.

As reported in the World Wealth Report (2007), increased transparency and

improved liquidity in the real estate market led High Net Worth Individuals (HNWIs)

to increase their allocations to real estate in 2006. Infact high net worth individuals

liquidated their investments in alternative assets to increase investments in the real

estate sector.

4.6 COMMODITIES

Commodities are raw materials such as crude oil, base metals such as gold, silver,

agricultural commodities, industrial and soft commodities. Commodities present an

attractive investment opportunity because they behave differently from other asset

23 https://my.axa.co.uk/genesys/aslimpweb?context=displayPage&content=inv-how-assets-property&path=page

55

classes and adding commodities to a portfolio can help diversify a portfolio and

reduce overall risk exposure of the portfolio.

Commodities unlike shares and bonds react well to unexpected inflation and hence

provide a good vehicle to protect the portfolio and diversify investment risk. The

shortage of supply to meet the growing demand has created a strong commodities

market. Commodities however have a high risk return profile like shares and

therefore it is most advisable to spread the commodity exposures over a wide range

of sectors. They are also very dependent on economic conditions and hence can

suffer when economic growth is slowing down [Guide to Asset Classes, (2007)].

4.7 ALTERNATIVE INVESTMENTS IN PORTFOLIOS

Alternative investments 24 are usually used by collectors and hobbyists but can also

provide significant diversification benefits in large portfolios as compared to

traditional assets. These investments are more suited to the wealthier and more

experienced investors as they are volatile and of high risk in nature. Due to various

market imperfections in information and market liquidity, alternative investments

offer unique risk reward opportunities not easily available through the inclusion of

traditional assets in the portfolios [Schneeweis and Pescatore, (1999)].

24 Although there is not set definition for alternative investments, they generally include art, structured products, hedge funds, private equity, and venture capital and so on.

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Figure 10: HNWI’s allocation of financial assets, 2004-2008F (%)

Source: World Wealth Report (2007), by Capgemini and Merrill Lynch, p. 17

Figure 10 above highlights the percentage allocation of the High Net Worth

Individual’s portfolio to various asset classes. As can be seen from the figure, in the

year 2006, allocations to the alternative investments segment fell from 20% to 10%

mainly because the HNWI’s liquidated their holdings in the alternative investments to

increase investments in the real estate sector. However, the report mentions this

only as a temporary tactical move in response to the higher performance currently

yielded by the real estate sector, rather than a long term asset allocation shift and

therefore projects a greater allocation to alternative investments in 2008.

4.8 INVESTMENTS OF PASSION

The World Wealth Report of 2007 took a detailed look at the High Net Worth

Individual’s (HNWIs) portfolio allocations in “investments of passion”. These

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investments of passion include: luxury collectibles, jewelry, art, sports related

investments and other collectibles. Using data from the Forbes Cost of Living

Extremely Well Index, the survey revealed that the cost of luxury goods and services

rose nearly twice as fast in 2006 than the cost of consumer products, signaling that

the demand for luxury goods is surpassing the demand for everyday consumer goods.

Among these investments of passion, high net worth individuals allocated the most

money to luxury collectibles, including automobiles, boats and airplanes. They

allocated 26% of their investments of passion dollars to luxury collectibles in 2006,

20% to art and 18% to jewelry, the report said.

According to Merrill Lynch analysts, although only a few wealth management firms

provide services for investments of passion, the potential for growth of these items

will trigger increased focus on this segment in the coming future.

However, even though the report classifies automobiles, boats and airplanes as

investments of passion, according to me such classification is questionable since

these so called investments of passion, depreciate in value as time progresses and

hence cannot prove to be true investments.

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CHAPTER FIVE: FINDINGS

This chapter discusses the wealth management models employed by four different

companies namely, Kotak Bank, Citibank, Motilal Oswal and Standard Chartered. The

customer segmentation, wealth management process, risk profiling and asset

allocation systems, product offerings, review and monitoring of portfolios are

discussed with respect to each of the four models.

5.1 KOTAK WEALTH MANAGEMENT MODEL

The Kotak Wealth Management Group today is one of the oldest and most respected

Wealth Management teams in India. Today they manage the wealth of over 3700

families. Of these, 93 are part of the top 300 families in India.

5.1.1 Customer segmentation

The retail customers represented by the lowest layer of the pyramid in Figure 11 are

those who have maximum investments of Rs. Half a million (Rs 500,000). The

second layer incorporates customers who have investments between half a million to

Retail Customers

Priority Banking

Pvt Banking

Figure 11: Types of Customers at Kotak Bank

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Rs. 10 million (Rs 10,000,000). This segment represents the Priority Banking Arm of

the Kotak group. The topmost layer represents the Private Banking/Wealth

Management arm of the Kotak group and includes customers who have investments

of Rs 10 million (Rs 10,000,000) and above.

5.1.2 The Wealth Management Process

Figure 12: The Investment Process Flow

As can be seen in Figure 12, the investment process flow for Kotak starts with

defining the client’s major goals. Extensive consultations with clients are held on

investment goals, horizons and desired rate of return. After defining these

parameters, Kotak conducts risk profiling for the client and based on client inputs,

the client’s risk profile and market conditions it designs an asset allocation plan for

its client. Once this asset allocation plan is approved by the client, Kotak implements

this allocation in terms of the various products offered by it. Continuous portfolio

Define major life goals

Desired Rate of Return

Conducting Risk Profiling for clients

Evolve an Asset Allocation

Implement Asset Allocation

Monitor Progress

New Goals or Priorities

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monitoring is done to keep it attuned to market changes and client goals. Any new

client goals or changing goals as defined by the client are then constantly

incorporated into the portfolio.

5.1.3 Asset Allocation

Based on the risk profile of the client and his specific needs, Kotak has segregated

their product offerings into four basic buckets namely: Capital protected with fixed

returns, capital protected with no fixed returns, capital at risk and other asset

classes. However, a client is not restricted to a particular bucket only. A portfolio can

be constructed comprising a mixture of assets from all the four buckets. At Kotak,

there is no set model or asset allocation plan to which the client can be allocated to;

it is a highly customized process and differs from client to client.

Following are the asset categories that fall into each of the risk buckets.

5.1.3.1 Capital Protected with Fixed Returns

Here the client is assured of recovering his capital as well as a fixed rate of return.

This bucket is generally favours conservative customers.

Table 1: Capital Protected with Returns

Bonds

Fixed Deposits

Fixed Maturity Plans

Liquid Funds

The products in the above table all guarantee fixed returns to the client.

5.1.3.2 Capital Protected with No Fixed Returns

This bucket entails full capital protection but here the client is willing to forego fixed

returns for the opportunity to earn higher returns.

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Table 2: Capital Protected with No Fixed Returns

Structured Products

• Nifty Debentures • Flexi Fund of

Funds

The two structured products in the table 2 offer the client customized investments to

meet his/her specific objectives. These are products are not directly available in the

market, but in house products are particularly designed for customers of Kotak Bank

only as per their needs.

The nifty debentures provide capital appreciation with upside Nifty participation. The

Flexi Fund of Funds series is a three year close ended scheme which aims to

preserve capital and provide upside participation on the equity markets.

5.1.3.3 Capital at Risk

This risk bucket comprises of clients who are willing to forego their capital for

earning high returns. This bucket entails high risk and aggressive customers.

Table 3: Capital At Risk

EQUITY • Relative Return Portfolio

- Diversified Mutual Funds - Index Funds

• Absolute Return Portfolio

As table 3 explains, this risk bucket comprises mainly of equity which is broadly

classified into relative return portfolios and absolute return portfolios. Where relative

return portfolios are beta based and consist mainly of diversified mutual funds and

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index funds, the absolute return portfolios are alpha based and are more

concentrated portfolios of about ten to twelve stocks.

5.1.3.4 Other Asset Classes

Table 4: Other Asset Classes

Commodities

Art Fund Real Estate Private Equity

As can be seen from table 4 above, this bucket mainly comprises of what we term as

alternative investments. These alternative investments are new avenues for

investments and their inclusion into portfolios depends on the client.

5.1.4 Product Offerings

Kotak provides one of the widest range of products to invest in

• 5.1.4.1 Portfolio Management Services

Kotak offers the construction and management of equity portfolios

using their expertise in equity capital markets.

• 5.1.4.2 Structured Products

Kotak offers structured products such as nifty debentures and flexi

fund of funds explained in table two.

• 5.1.4.3 Mutual Funds

Kotak offers research based recommendations on various mutual

funds. It has tie ups with the following mutual funds:

• DSP Merrill Lynch Mutual Fund

• HDFC Mutual Fund

• Fidelity Mutual Fund

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• Birla Sunlife Mutual Fund

• Reliance Mutual Fund

• Prudential ICICI Mutual Fund

• HSBC Mutual Fund

• Tata Mutual Fund

Besides tie ups with the following mutual funds, Kotak has its own in

house mutual funds too such as Kotak 30 Fund, Kotak Mid Cap Fund,

Kotak Global India and Kotak Liquid.

• 5.1.4.4 Private Equity

The private equity fund aims to achieve long term capital appreciation

through investments in privately negotiated equity and equity related

investments in emerging public limited companies.

• 5.1.4.5 Real Estate

The Kotak India Real Estate Fund has been organized as a scheme of

the Kotak Mahindra Realty Fund, a close ended venture capital fund

with a focus on the Indian real estate and allied sectors.

According to Vodhisatta Chakravartty, Associate Vice President at Kotak Wealth

Management, “At Kotak, we offer everything under one umbrella and cover all asset

classes right from art to debt instruments”.

5.1.5 Mutual Fund Recommendation Process

Recommendations at Kotak are based on an extensive analytical process which has

been developed in house. Emphasis is given for consistency in performance, a sound

and consistent investment philosophy and portfolio quality. The process has four

stages:

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1. Due diligence on Asset Management Companies (AMC’s): Kotak focuses on

various qualitative parameters such as AMC’s pedigree, assets under

management, service capabilities and management team.

2. Classification as per the nature of the scheme: The classification is based on

the nature of investments made by the scheme, such as debt funds, short

term income funds, liquid funds etc.

3. Analyzing consistency in performance: Kotak follows the risk to reward ratio

for analyzing consistency in performance. They rank funds on the Excess

Returns Potential (ERP) ratio. This measure helps them determine how

consistent the fund is in generating returns and showing lower downside.

4. Analyzing portfolio risk: A detailed study of the portfolio is undertaken to

assess how the returns were generated and how much risk the fund has

taken to earn that return. Both the market risk and the credit risk is analyzed.

Based on an extensive analysis of all these parameters, Kotak recommends those

schemes which show higher consistency in performance with lower or reasonable

portfolio risk.

5.1.6 Portfolio Review

Client portfolios are reviewed based on market conditions and client goals. Normally,

portfolios are reviewed once a month but frequent reviews can also be done

depending on the client’s needs. The clients are sent updates regularly generally

every two weeks. Kotak also has a management information system (MIS) in place

which automatically updates client portfolios.

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5.2 CITIBANK WEALTH MANAGEMENT MODEL

The wealth management group of Citibank is known as Citi Investment Services.

5.2.1 Customer Segmentation

Figure 13: Types of Customers at Citibank

As can be seen from figure 13 above, Citibank segments its customers into four

categories. G0 customers are those who have financial assets less than Rs 3 million

(Rs 3,000,000). G1 have financial assets in the range of Rs 3 million to Rs 10 million

(Rs 10,000,000). G2 have financial assets between Rs 10 million to Rs 25 million (Rs

25,000,000) and G3 are those who have financial assets of over Rs 25 million. The

G1, G2 and G3 customers are known as Citigold Customers (CG) and are managed

by the Citigold Relationship Managers. The G0 segment is known as Citiblue (CB)

and customers in this segment are managed by the Citiblue Relationship Managers.

G0 - Citiblue

G1 - Citigold

G2 - Citigold

G3 CG

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5.2.2 The Wealth Management Process

Figure 14: Citibank Wealth Management Process

The Citibank wealth management process is broadly classified into two steps. The

first step begins with Citipro, the in house Financial Managing Tool. It helps assess

the client’s existing wealth, cash flow requirements, risk appetite and investment

horizon. The client’s profile and cash flows determine the optimal portfolio allocation

into liquid assets, medium term and long term investments. It also helps rationalize

the client’s existing liabilities and determine his insurance requirements. It thus

enables the client to preserve, protect and grow his wealth.

The second step pertains to product selection and portfolio review and rebalancing

using Citichoice. The client can select from a shortlist of top performing mutual funds

in each of the liquid, debt and equity fund asset classes from leading fund houses in

India. Depending on his risk tolerance (termed as “appetite” in Citibank), a variety of

Citipro

• Customer Profiling

• Portfolio

Allocation

Citichoice

• Product Selection

• Portfolio Review

• Rebalancing

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other products are also offered such as government of India fixed income securities,

treasury bills, structured products and so on.

At Citibank, the wealth manager actively monitors the client’s portfolio and keeps

him abreast with the updated status of his investments. The client also receives a

portfolio tracker that contains details on his portfolio performance against his

financial plan and provides a systematic opportunity to rebalance investments.

5.2.2.1 Citichoice

Citichoice is the fact sheet of various funds, published by Citibank every quarter. At

Citibank, they guide their customers to the right choice of investment funds through

their globally renowned fund selection process, Citichoice. In depth research based

on fund ratings is conducted. The Citi Investment Analysts then conduct a detailed

analysis of the fund performance and thoroughly examine the fund management

team. The results are then reviewed by an advisory committee who decides which

funds to make available for recommendation to customers.

Strategic Citichoice funds are funds selected on comprehensive parameters such as

superior return score, industry concentration, company concentration, liquidity and

asset size. Apart from these strategic Citichoice funds, other funds such as the

dividend yield, mid cap funds and focused funds form a part of the tactical allocation

of Citichoice.

5.2.3 Risk Profiling and Asset Allocation

Citibank administers a paper based questionnaire to gauge the risk profile of its

customers. This questionnaire is the personal investment risk profile and consists of

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seven questions. Four of these questions carry scores. Once the client has filled this

questionnaire, based on their answers their total score is computed.

Based on these scores, Citibank has designed investment profile and risk ranking for

the scores obtained. Each investment profile has different allocation to bonds,

equities and recommendations for global investment products.

Table 5: Profile and Asset Allocation Models at Citibank

As can be seen from table 5, Citibank has six customer profiles and based on these

profiles it has recommended sample portfolio solutions for each of them. For

example, if the customer is P5 then 30% of his portfolio should be invested in bonds

and 70% in equities. The risk ranking is based on the risk profile. The higher the

ranking, the riskier the customer and therefore higher the profile. For a detailed

understanding on each profile and its associated investment products, please refer to

the attached personal investment risk profile form in appendix 8.1.

However, it is important to note that strict adherence to these profiles and

allocations above are not mandatory. The profile does not cover all issues to be

considered while investing, but offers a general framework. Various other aspects

Investment Profile Risk Ranking Portfolio Solution

Liquid Bonds Equity

P1 Risk Averse 1 100%

P2 Income 2 100%

P3 Conservative 3 80% 20%

P4 Balanced 4 50% 50%

P5 Growth 5 30% 70%

P6 Enhanced Growth 6 10% 90%

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such as the client’s need base, profession are also covered and incorporated into the

asset allocation process.

5.2.4 Product Offerings

Citibank offers a variety of products which are listed below:

• Bonds

• Insurance

• Mutual Funds

• Structured Products

• Direct Equity Advisory

Citigold makes use of the in house tool, Wealth Planner, to construct client’s

portfolios. Once the goals and profile of the client is determined, they use the Wealth

Planner to build a diversified and efficient portfolio of different asset classes. At

Citibank, they make use of sophisticated investment tools so that the client is aware

of the potential risks and rewards.

Citigold wealth management also offers exclusive privileges that comprises of tax

and estate advisory services, free for life Citibank international gold credit card,

updated information on treasury and currency markets and free access to airport

lounges at domestic and international airports in India.

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5.2.5 Product Ratings

Citibank has an in house research base known as the Citigroup Global Market, which

evaluates the performance of various products. It also has access to the award –

winning global market research of Citigroup Smith Barney.

5.2.5.1 Rating Process

At Citibank, mutual fund house rating is a five step process which is illustrated in the

diagram below:

Figure 15: Citibank Fund Rating Process

As the above figure depicts, the process starts with screening of funds from a

universe of funds available. A qualitative as well as quantitative screening is then

done based on various parameters such as risk adjusted return, liquidity risk, asset

quality, average maturity and mark to market component, asset size and many

others. Once the funds are rated quantitatively and qualitatively, they are published

in Citichoice.

Universe of Funds

Fund house Screening

Qualitative Screening

Quant. Screening

Citichoice

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5.2.6 Portfolio Review

Reviewing and rebalancing of portfolios is done regularly, depending on the client.

Clients are updated regularly and face to face meetings are held with the client every

fortnightly.

Citibank also has a Portfolio Tracker system which is an automated system that

generates a one stop report of the client’s assets, liabilities and investment

performance. It gives simple to understand assessment of the client’s finances and

performance. This helps the clients monitor their portfolios regularly and fine tune

their investments as when required.

5.3 MOTILAL OSWAL WEALTH MANAGEMENT MODEL

Motilal Oswal’s newest platform: wealth management provides comprehensive

wealth management solutions to cater to the client’s wealth management needs.

5.3.1 Customer Segmentation

Figure 16: Types of Customers at Motilal Oswal

Retail Segment

Mass Affluent

Super HNI

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As can be seen from the above pyramid in figure 16, Motilal Oswal segments its

customers into three tiers. The bottommost layer is the retail segment and

comprises of customers with financial assets of less than Rs 1 million (Rs 1,000,000).

The second layer is the mass affluent segment, alternatively known as the Mid Tier

Millionaire (MTM) segment, consisting of clients with financial assets between Rs 1

million to Rs 50 million (Rs 50,000,000). The topmost layer is the super high net

worth individuals (HNI) who have financial assets of over Rs 50 million.

5.3.2 The Wealth Management Process

Figure 17: Wealth Management Process at Motilal Oswal

Risk Profiling

Assign to category

Need Analysis

Asset Allocation

Tracking

Cash Flow Analysis

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The wealth management process at Motilal Oswal starts with conducting a review

and analysis of the client’s existing portfolio along with his cash flow analysis. A

needs analysis is then carried out through consultations with the client on investment

goals and horizons. After defining the client’s goals and needs, Motilal Oswal

conducts risk profiling for its customers to determine the client’s appetite for risk.

The client is then assigned to the appropriate category i.e. risk averse, conservative,

moderate or aggressive risk taker. Depending on his risk category, an asset

allocation plan is implemented for the client. Continuous portfolio reviewing and

rebalancing is done to keep it aligned to the client’s goals, needs and expectations.

5.3.3 Risk Profiling and Asset Allocation

Motilal Oswal profiles its clients into various risk categories by administering a paper

based questionnaire, prepared by the compliance department. Although the

questionnaire was not disclosed to me, the questions asked revolve around the

client’s age, objectives, investment horizon, dependants and preferences. These

questions help categorize the client into one of the four risk categories.

Asset allocation at Motilal Oswal is based on two parameters:

• Profile of the customer

• Expectation of the customer

The asset allocation advice aims to create a balance between the above two

parameters. For example, if the profile of the customer is a conservative risk taker

but the customer has expectations of very high returns, then the wealth manager at

Motilal Oswal through extensive reviewing with the customer either tones down

customer expectations or increases his risk appetite. Hence, the asset allocation

process is an extremely customized process, unique to each customer. For example,

74

two customers both with aggressive risk profiles could have different asset

allocations to their portfolios.

5.3.4 Product Selection

Motilal Oswal has an internal research team comprising of 40-50 people that

conducts research on various product offerings. The research is sector based.

Besides this, an internal product team headed by the product manager decides the

product mix. Finally the investment advisors, based on the profile of the customer

recommend such products to the client.

Motilal Oswal offers a variety of products which are listed below:

• Bonds

• Equity Advisory

• Commodities

• Mutual Funds

• Insurance

• Derivatives

Structured products and alternative investments such as real estate and private

equity do not form a part of Motilal Oswal’s product base, since it is a new entrant in

this field and hence still developing its product base.

5.3.5 Portfolio Review

Portfolios are reviewed once a month for the MTM segment as well as the retail

segment. However, while updates are sent via mail to the retail segment, the

advisors meet with the MTM segment personally to review their portfolios. For the

super HNWI segment, meetings are held with the clients once every two weeks.

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Quantitative as well as qualitative portfolio reviewing is done. The qualitative

mechanism deals with a customer relationship package for advisors which updates

them on the status of client portfolios and generates reminders for the advisors. The

quantitative mechanism deals with a Wealth Management Software at Motilal Oswal,

which generates net consolidated statements of the client’s holding and his portfolio.

Hence, constant reviewing and rebalancing of portfolio is done to keep it aligned with

market conditions and client’s needs and goals.

5.4 STANDARD CHARTERED WEALTH MANAGEMENT MODEL

Wealth management at Standard Chartered is known as Standard Chartered

Investment Services (SCIS).

5.4.1 Customer Segmentation

Figure 18: Types of Customers at Standard Chartered

Retail Customers

HNWIs

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Standard Chartered broadly segments its customers into two categories. The retail

segment can avail branch banking services at Standard Chartered, whereas the High

Net Worth Individuals (HNWIs) can avail of the Priority Banking services. The

minimum investment limit for these high net worth individuals is Rs 2 million (Rs

2,000,000) and above.

5.4.2 The Wealth Management Process

The wealth management process at Standard Chartered is a three step investment

process.

Figure 19: Wealth Management Process at Standard Chartered

As can be seen from figure 19 above, the three steps in the wealth management

process are plan, build and protect. In the first stage: plan, Standard Chartered uses

various financial tools to analyze the customer’s current situation, needs, risk

appetite and charts out the best plan to meet the client’s goals. Under consultation

with professional, competent and certified relationship managers, they help work out

the client’s investments with investment profiles reflecting his risks and preparing a

strategy combining several investments that fulfill the client’s financial requirements.

In the second stage namely build, SCIS the plan to grow the customer’s wealth

through a wide range of portfolio management products and solutions. A series of

integrated investment products are used that gives the client an opportunity to

develop his assets for optimum results.

BUILD PLAN PROTECT

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In the third stage, Standard Chartered helps maintain the value of the portfolio that

is built in the previous stage and ensures sufficient protection for the client by

constantly reviewing his investments. Review of the client’s investments, observation

and adjustment on a periodical basis all form a part of this last stage.

5.4.3 Risk Profiling and Asset Allocation

Standard Chartered does its profiling in two parts for its customers

• Know Your Customer

• Common Transaction Form

Know Your Customer (KYC) is carried out through a customer suitability assessment

form. This is a paper based questionnaire containing questions regarding the

investor’s background, investment objective, risk preferences and so on. There are

two separate forms, one for investments above Rs 2.5 million and one for

investments below Rs 2.5 million. For investments below Rs 2.5 million, a score

based customer suitability assessment form (see Appendix 8.2) is used where scores

are assigned to each question and based on the total score of the investor,

investments are recommended by the advisor. For investments above Rs 2.5 million

(see Appendix 8.3), the questionnaire comprises of qualitative questions to find out

the investor’s risk appetite and classify him accordingly.

After the customer suitability assessment, each investor is required to fill out the

common transaction form which records all the personal details of the investor and

his dependants.

After profiling the customer into the respective risk categories, asset allocation is

carried out by the bank in two parts, i.e. strategic allocation and tactical allocation.

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Strategic allocations are carried out for long term investments and tactical allocations

are carried out short to medium term investments. There are no set asset allocation

models prescribed by the bank, the process is customized and unique to each

customer and his needs.

5.4.4 Product Selection

Standard Chartered offers one of the widest ranges of investment products to its

customers. These are:

• Mutual Funds

Standard Chartered has tie ups with various mutual funds such as Birla

Mutual Fund, DSP ML Mutual Fund, Fidelity MF, Franklin Templeton Mutual

Fund, HDFC Mutual Fund, HSBC Mutual Fund, Prudential ICICI Mutual Fund

and Reliance Mutual Fund.

• Portfolio Management Services

• Real Estate

• Structured Investments

Standard Chartered has the widest structured products programme that

caters to both sophisticated and new investors. Its structured products are

divided into capital protected products and non capital protected products.

• Insurance

• Bonds

• Commodities

These products are carefully chosen after feedback from research team and once

approved by the product team.

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5.4.5 Portfolio Review

Client portfolios are reviewed and updated regularly to keep it aligned with market

conditions and client goals. Weekly review of the markets and monthly broker polls

are conducted. The bank also makes use of an in house fund analyzer that gives an

in depth review of various schemes.

Standard Chartered has a in house developed wealth management software that

provides clients with regular updates and consolidated statements of their net

holdings in their portfolio. Regular review meetings are also held with the clients on a

face to face basis. Besides this, a monthly magazine called Invest Pro is published by

the bank for its clients, which consists of market reviews, sector and company

analysis and star ratings.

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CHAPTER SIX: ANALYSIS AND CONCLUSION

The table below summarizes the key differences between the four wealth

management models explained in the previous chapter based on seven different

parameters, i.e. customer segmentation, the wealth management process, risk

profiling, asset allocation, products offered, research and portfolio reviews and

updates. After which, I have attempted to expand each of these parameters and

explain in detail the key differences.

COMPARISON OF THE WEALTH MANAGEMENT MODELS

BASIS KOTAK CITIBANK MOTILAL OSWAL STANDARD CHARTERED

Retail: upto Rs 5 Lakhs G0:< 30 lakhs Retail: <10 lakhs Retail: Nil

Customer Segmentation

Priority Banking: 5 lakhs - 1 crore

G1: 30 lakhs - 1 crore Mass Affluent: 10 lakhs - 5 crores

HNWI: 20 lakhs and above

Private Banking: 1 crore + G2: 1 - 2.5 crores Super HNWI: 5 crores +

G3: 2.5 crores +

Process Define Major Life Goals Profiling Cash Flow Analysis Plan

Profiling Asset allocation Need Analysis Build

Evolve an Asset Allocation Product selection Risk Profiling Protect

Implement Asset Allocation Portfolio review Assign to Category

Monitor Progress Rebalancing Asset Allocation

New Goals and Priorities Tracking

Risk Profiling

Not disclosed Score based personal investment risk profile questionnaire

Paper based questionnaire prepared by compliance dept

2 parts: � KYC(Know Your Customer) � Common Transaction Form

6 profiles 4 risk categories Two separate forms: � above Rs 25 lakhs � below Rs 25 lakhs

Asset Allocation

4 asset buckets � Capital protected with

fixed returns � Capital protected with no

fixed returns � Capital at risk � Other asset classes

Each of the six profiles has different allocations to bonds and equities

2 factors: � profile of customer � expectation of customer

2 kinds: � strategic asset allocation � tactical asset allocation

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Flexible and customized Flexible Customized and unique to each customer

Customized

No set allocation models No set allocation models

Products Bonds Bonds Bonds Bonds

Mutual Funds Insurance Insurance Insurance

Equity Mutual Funds Mutual Funds Mutual Funds

Private Equity Direct Equity Equity Equity

Real Estate Structured Products Commodities Real Estate

Commodities Derivatives Commmodities

Art Structured Products

Structured Products

Research

In house research dept In house research dept known as Citigroup Global Market

Internal research team of about 40-50 people

Internal research team

Access to global market research of Citigroup

Sector based

Smith Barney

Review and MIS Citichoice WMS WMS

updates Updates sent to clients every two weeks

Portfolio Tracker Review meetings once a month for MTM

Fund Analyzer

Face to face meetings held fortnightly

Review meetings once every two weeks for super HNWI

Invest Pro

Regular meetings

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6.1 COMPARATIVE ANALYSIS OF WEALTH MANAGEMENT MODELS

While dealing with customer segmentation, only Standard Chartered has a two

tier segmentation. The remaining three banks have either a three or four tier

segmentation, which makes it a comprehensive system of segmentation and allows

the bank to cater to the needs and goals of each class more specifically. It is

important to note that all the four banks follow the fixed investment model, while

segmenting clients and not the revenue based model, i.e. they segment clients on

the basis of their investments rather than the client profitability generated for the

bank. Following a revenue based model while segmenting clients is a subjective

process and hence not a very effective process. In my model therefore, I have

employed the fixed investment model of segmenting customers to reduce

subjectivity and implement a standard system of segmenting customers.

The wealth management process followed by each bank is quite similar. All of

them start with an analysis of the clients existing cash flow needs and wealth

situation, move on to risk profiling and asset allocation and then to the final step of

reviewing and rebalancing the client’s portfolios. Although the broad outline of the

process remains the same, the intricacies within each step differ from bank to bank

For example; Citibank and Standard Chartered make use of sophisticated tools to

analyze the client’s existing wealth and cash flow requirements. On the other hand,

Kotak and Motilal Oswal conduct such analysis through extensive consultations with

their clients. In my model I have employed sophisticated tools along with extensive

consultations with clients as part of the wealth management process.

The risk profiling system followed is quite different too. Although all the banks have

a paper based questionnaire administered to their clients, Citibank and Standard

Chartered follow a quantitative method of risk profiling. They have a score based

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questionnaire through which they categorize their clients into risk categories based

on their total score. Standard Chartered has the most comprehensive risk profiling

system, with two separate forms for investments above Rs 2.5 million and below Rs

2.5 million. However, it is important to note that although all the banks administer

questions revolving around the client’s age, investment objectives, horizon and risk

preferences, none of them actually administer any personality tests to gauge the

true personality of the investor which allows for better categorization into different

risk profiles. This issue has been considered while developing my model. In addition,

in my model risk profiling has been addressed using a blend of both quantitative as

well qualitative approaches.

Asset Allocation in all the banks is quite flexible and customized to a client’s needs.

Although Kotak and Citibank have sample asset allocation models, strict adherence

to them is not necessary. Asset allocation at Motilal Oswal is the most customized as

it formulates a model for each customer separately based on the risk profile and the

expectation of the customer. Hence all the banks follow an integrated asset

allocation strategy as discussed in chapter two which integrates client risk tolerance

along with client goals. A constant weighting allocation strategy is also followed by

all banks where client portfolios are regularly reviewed and rebalanced in contrast to

the buy and hold strategy. In my opinion, having sample asset allocation models

proves to be a beneficial strategy, in terms of having an established framework to

refer to. However, such models should not be rigid; considerable flexibility should

exist to alter the models according to each client’s specifications.

In terms of product offerings, Kotak and Standard Chartered offer the widest

range of investment options for its customers, right from bonds to structured

products. This is also because they have considerable expertise in the field of wealth

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management. Citibank however has limited product offerings inspite of its existing

expertise and age. Motilal Oswal also offers fewer products and alternative

investments and structured products do not form a part of its product portfolio. This

is however attributed to the fact that it is new entrant in the field of wealth

management.

In terms of research, all the banks have internal research teams. I feel however, tie

ups with external research houses/rating agencies would help give an unbiased view

on product selection besides providing additional expertise. This however would

prove to be more expensive and only well established companies would be able to

afford such extensive tie ups.

Review of portfolio and updating clients is a regular procedure in each of the

banks. Citibank and Standard Chartered however make use of sophisticated tools

such as the Portfolio Tracker and Fund Analyzer in addition to the wealth

management software and also have publications such as Citichoice and Invest Pro

for its clients. Such publications keep clients well informed about market

performance and consist of important information to help clients make well informed

decisions.

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6.2 COMPREHENSIVE WEALTH MANAGEMENT MODEL

Having analyzed the differences between the four models, I have developed my own

comprehensive wealth management model incorporating the key points of the four

models studied above.

6.2.1 Customer Segmentation

Figure 20: Types of Customers

In my model, I have employed the fixed investment model of customer

segmentation in contrast to the revenue based model to eliminate subjectivity and

implement a standard method of segmenting customers. Here customers are

segmented into four tiers in terms of their investments. The bottommost layer

represents customer who have investments upto Rs 2.5 million, the second layer

includes customers having investments in the range of Rs 2.5 million to Rs 10 million.

The third layer comprises of customers who have investments in the range of Rs 10

million to 50 million. The fourth layer, i.e. topmost layer represents customers who

have investments of Rs 50 million and above.

< Rs 2.5 million

Rs 2.5 Mn - Rs 10 Mn

Rs 10 Mn – Rs 50 Mn

50 Mn

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Each tier will have a separate channel of relationship managers. By segmenting

customers into four tiers, the company will be able to understand the needs and

goals of each segment better and therefore allow for better service and client

satisfaction.

6.2.2 Wealth Management Process

In this model, the wealth management process is divided into three broad phases,

namely: defining client profile, portfolio construction and portfolio review. Each

phase in turn is divided into sub steps. Let us now look at the model in detail.

WEEK 1-2 WEEK 3-4/ MONTH 1 EVERY MONTH

Phase 1 Phase 2 Phase 3

Defining Client Profile Portfolio Construction Portfolio Review

• Existing Portfolio review

and analysis • Asset allocation model • Changes in client goals

• Client goals and horizons • Setting up a strategy • Market changes

• Personality testing • Product selection • New goals

• Assign to category • Rebalancing

Figure 21: Wealth Management Process

Phase 1 begins with using in house developed sophisticated financial tools such as

those employed by Citibank and Standard Chartered to assess the client’s current

situation, existing wealth and cash flow requirements. Consultations are held with

clients on their goals, needs and investment horizons. After establishing these

parameters, appropriate risk profiling is carried out to establish the client’s tolerance

for risk. Clients are put through a personality test to accurately determine their

tolerance for risk. Based on their tolerance for risk, the clients are assigned to the

appropriate risk category. In our model, we have five risk categories i.e. risk averse,

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conservative, balanced, aggressive and very aggressive, elaborated later in the next

section. Phase one is carried out in the first one to two weeks once the client opens a

wealth management account with the bank.

Phase 2 involves construction of an appropriate asset allocation model based on the

client’s tolerance for risk and the risk category he falls into. A strategy is formulated

for the client for tactical divestments or exit from current investments, for plugging

gaps in the current asset allocation and for planning cash flows for future allocations.

Once the asset allocation model is determined, implementation of the asset

allocation model is carried out in terms of the various products offered by the bank.

A diversified and efficient portfolio of various asset classes is built for the client.

Phase two is carried in week three and four after the client opens an account with

the bank.

Phase 3 involves portfolio monitoring, reviewing and rebalancing. Changes in client

life cycle, new goals and preferences are all incorporated into the portfolio. Client

portfolios are reviewed regularly to keep it aligned to changing market conditions

and client goals. Reviewing and rebalancing, when necessary, of portfolios is

generally carried out every month once the client’s portfolio is built.

6.2.3 Risk Profiling and Asset Allocation

In this model, risk profiling is carried out in two steps:

• Risk Profile Form

• Personality Testing

The first is a basic risk profiling form, which is a paper based questionnaire and

consists of questions such as investor’s age and background, investment objectives,

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future plans, risk preferences, past investment patterns and so on. Like the Citibank

and Standard Chartered questionnaire, it is a score based questionnaire where

scores are assigned to each question and based on the client’s responses, the total

score is computed. This is the quantitative approach to risk profiling.

The second step involves profiling investors by personality type. This step is carried

only for the top two layers of the customer pyramid, since it requires considerable

time, expertise and money. These customers are asked to take personality tests

such as the Myers – Briggs Type Indicator® which helps gauge the customer’s true

personality. This enables advisors to create strategies for customers that eliminate

individual biases introduced during the basic risk profiling stage and save them the

frequent costs of rebalancing their portfolio. Personality testing in addition to basic

risk profiling will help the advisor categorize the customer more effectively into one

of the five risk categories. This is the qualitative approach to risk profiling.

Hence by employing, quantitative as well qualitative approaches to risk profiling in

my model, risk profiling is carried out in a more accurate fashion than in any of the

previous models studied.

The five risk categories in my model are:

1. Risk Averse – This category includes investors who are not willing to accept

any risk and any short term fluctuation in returns.

2. Conservative – This category includes investors who are willing to accept a

very slight short term fluctuation for potential higher returns.

3. Balanced/Moderate – Investors here are willing to accept occasional short

term losses for potential higher returns.

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4. Aggressive – This category includes investors are willing to accept significant

fluctuations in returns and losses for potential higher returns.

5. Very Aggressive – Investors here are able to accept significant fluctuations in

returns and also forego their capital for earning higher returns.

Based on the five risk categories above, sample portfolio allocations are

recommended in the table below. The table below integrates the risk allocation

framework by Chhabra (2005) and the asset allocation goals by Brunel (2003) to

develop sample asset allocations.

Table 6: Sample Asset Allocations

Profile Three Dimensions of Risk Goals

Personal Market Aspirational

Risk Averse All Nil Nil Liquidity

Conservative Large Medium Small Capital Preservation

Balanced Medium Medium-Large Small-Medium Income

Aggressive Small-Medium Medium-Large Medium-Large Growth

Very Aggressive Small-Nil Medium-Large Large Growth

Table 6 above, highlights the five risk categories and their allocations to each risk

dimension along with their matched goals. A risk averse investor will allocate his

entire portfolio to the personal risk category to minimize downside risk and for safety

purposes. This helps achieve the goal of liquidity which cannot bear the risk of any

downward volatility. The conservative investor has allocations mainly to the personal

and market risk category to preserve and maintain lifestyle and standard of living.

This is consistent with the goal of capital preservation which avoids significant

decrease in the value of his capital. The balanced investor has more allocations to

the aspirational risk bucket, since he takes measured risk to earn higher returns,

thus corresponding to the income goal which represents the need for higher cash

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flows to maintain lifestyle. The aggressive investor has large allocations to the

aspirational risk bucket to enhance lifestyle and break away from the current wealth

segment. The very aggressive investor too has a major portion of his portfolio

allocated to the aspirational risk segment and very small or almost nil allocations to

the personal risk bucket since he is willing to forego capital to earn higher potential

returns. Both the aggressive and very aggressive investor has needs that

correspond to the growth goal, which allows for capital appreciation.

It is important to note that the table above is only a sample asset allocation model

and strict adherence to the table is not necessary. It only offers a general framework

and client inputs and preferences must be taken into account while implementing the

asset allocation plan. Hence, it will prove to be a flexible and customized process.

6.2.4 Products Offered

This model will offer the widest range of investment products to invest in:

• Bonds

• Insurance

• Mutual Funds

• Direct Equity Advisory

• Commodities

• Derivatives

• Real Estate

• Art

• Private Equity

• Structured Products

Hence, this model will include the entire gamut of investment products available

today right from basic investment vehicles such as bonds to upcoming investment

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avenues such as art and structured products. By including the entire range of

investment products, this model will be able to cater to every segment effectively by

offering products for every type of customer.

Product ratings and recommendations will be based on an extensive research

process carried out by the in house research department as well as an external

agency. I believe that a tie up with an external agency, although expensive, will

provide an unbiased view on the entire range of investment products.

6.2.5 Portfolio Review and Rebalancing

In this model, portfolio review and rebalancing revolves around three main aspects.

The first, portfolio tracking, involves regularly monitoring the portfolio as against its

stated goals and objectives. It includes using state of the art and sophisticated

analytical tools to closely monitor the progress of the portfolio. It also involves

generating net consolidated statements of the portfolio’s holding and a one stop

report of the portfolio performance. For the topmost two segments of the customer

pyramid, monitoring of the portfolio will be done more frequently as compared to the

bottom two layers, for whom monitoring is generally carried out once a month.

The second aspect involves face to face meetings with the clients and sending

updates to the client’s on their holdings. Regular review meetings are held only with

top two layers of clients. Updates via mail are sent to the bottom two layers of

clients. Consultations with clients about their changing goals, horizons and

preferences are all incorporated into the portfolio while rebalancing.

The third aspect relates to investor magazines and publications that comprise of

weekly review of markets, broker pools, market conditions, and sector and company

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analysis and so on. These publications give the client an in depth view of the market

condition and happenings that help make informed decisions.

6.3 CONCLUSION

Having studied the strengths and weaknesses of the four company models along with

the comprehensive wealth allocation model, I now wish to conclude by stating that

the wealth management models in practice today are broadly consistent with the

theories outlined in chapter two.

Chapter two talks about integrating the Harry Markowitz Modern Portfolio Theory

(MPT) along with the works of various behavioural finance theorists in building an

effective portfolio. All the models discussed in chapter five are consistent with the

works of Daniel (2004) and Curtis (2004) who suggest combining the Modern

Portfolio Theory along with the behavioural finance theory into one advisory process.

The wealth management process followed in the banks is similar to the three step

approach recommended by Curtis (2004) in designing client portfolios.

By understanding client goals, needs and profiling them into various risk categories

and then implementing sample asset allocation models to achieve efficiency

combines the efficient frontier theory by Harry Markowitz along with the behavioural

finance approach, thus merging both the approaches into the wealth management

process.

A wide range of investment products are also offered by most banks, studied in

chapter four. All the banks except Motilal Oswal offer the widest array of investment

products right from the basic products such as bonds and mutual funds to newer

investment avenues such as structured products, art and real estate. Hence all the

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companies are incorporating the three dimensions of risk proposed by Chhabra

(2005) in his wealth allocation framework i.e. personal, market and aspirational risk

by offering the most basic products such as bonds and mutual funds that protect

from downside risk (personal risk) to products that significantly enhance lifestyle

(aspirational risk) such as structured products, art and real estate.

Also, as can clearly be seen from the models, companies are increasingly moving

from traditional investment models to client centric, needs based, dynamic models of

wealth management as explained in chapter two. By segmenting clients beyond

demographics, based on behavioural characteristics and aspirations, by offering

products on a needs based approach and conducting ongoing reviews based on

behavioural dynamics and analysis, leading firms are adopting a dynamic needs

based approach by attempting to understand client’s needs beyond just products and

services.

In conclusion, after studying the four models described in chapter four, my

comprehensive wealth management model seeks to address an important weakness

inherent in the above four models, that is, differentiating between the various

segments of customers. In the comprehensive wealth management model, the two

top customer segments are treated differently in terms of risk profiling and reviewing

of portfolios than the bottom two customers segments. This model, therefore aims to

provide a robust model which can be employed by private banks today.

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6.3.1 The Wealth Management Proposition/Recommendation

Based on the analysis of the four company models and after developing the

comprehensive wealth management model, I have identified five different

parameters that make up the wealth management proposition and help create a

successful wealth management practice for a firm.

Figure 22: The Wealth Management Proposition

Client relationships should at the core of every wealth management model.

Companies are now recognizing the importance of client feedback and satisfaction

and transforming their models from traditional investment models to needs based

client centric models. Building long term and quality relationships with clients is an

important determinant of client satisfaction. Emphasis should be placed on a

structured and systematic investment approach that is based on a detailed step

by step investment process. Quality people should be recruited to ensure that

correct advice is provided by them. Investment advisors should undergo mandatory

training before they can serve clients and on going training programs should be

rendered all throughout the year. A wide range of investment products should be

offered for investment to clients. This should also include recent innovative

products such as art funds, hedge funds, private equity and structured products

that are now upcoming investment avenues. A dedicated servicing team of

investment advisors, relationship managers, back end research and tie up with an

external research agency should be operational. Investment advisors along with

relationship managers should provide the entire gamut of investment services along

Relationship Systematic Approach

Quality People

Innovative Products

Servicing Team

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with financial planning. The research department should ensure stringent quality

checks on products, conduct in depth research to aid decision making and publish

accurate ratings and recommendations on investment products.

Hence in today’s wealth management industry, in order to be successful advisors of

tomorrow, companies must alter and expand their services to include the above

parameters and respond to the constantly changing industry dynamics.

6.4 LIMITATIONS OF THE RESEARCH

• This dissertation is based on the models of four banks only. As I have

employed the qualitative methodology, considerable time was required for

prior appointments and interviews and hence the analysis is based on the

models of four banks only.

• This is my first attempt at a qualitative research project. Considerable

expertise and skill are required in conducting interviews and hence, the

results in this dissertation may not be the same as those conducted by a

skilled researcher

• There are various asset classes used in constructing portfolios but only the

basic ones have been discussed in this study due to time constraints.

• Due to compliance issues, banks may not have disclosed all the information

necessary; analysis may be based on part information and therefore not

completely accurate.

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APPENDICES

8.1 Appendix 1: Citibank Risk Profiling Form

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8.2 Appendix 2: Standard Chartered Score Based Form

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8.3 Appendix 3: Standard Chartered Customer Suitability Form

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