Discretionary portfolios a growth area for private banks

ASIAN private clients are often said to be self-directed and transactional. A growing number, however, is gravitating towards discretionary portfolios. These are portfolios where full control of the assets is handed over to an asset manager. The client pays a portfolio fee that is on top of underlying funds' annual management fees.

Banks seek to expand DPM (discretionary portfolio management) services as they are a means to generate a recurring fee income, unlike the spreads earned from transactions which are subject to volatility and uncertainty.

Historically, penetration of DPM has been low at less than 5 per cent. But this seems to be creeping upwards. Says Rajeev De Mello, Bank of Singapore's chief investment officer: "We have seen a significant increase in demand for DPM services since 2010 which has translated into remarkable growth in our DPM assets under management."

As at August, BOS had some US$8 billion in DPM assets, and this has grown by over 50 per cent since end-2016. DPM assets account for about 7.8 per cent of BOS' total private banking AUM of US$102 billion. Lombard Odier chief investment officer Asia Pacific, Jean-Louis Nakamura, reports that the bank's DPM assets account for as much as 65 per cent of total AUM in Asia, "very far above" the industry average. Over the past two years, growth has come in at a clip of more than 20 per cent a year.

UBS has declined to disclose DPM assets among Asian clients, but an indication can be found in the warm response to the launch of its first sustainable investment mandate, which raised over US$100 million from Asia-Pacific clients, and over US$2 billion globally.

Mischa Eckart, managing director and APAC head of client investment specialists, UBS Global Wealth Management, says DPM is an area of strong growth. "We position DPM as a tool for clients to take control of their portfolio by setting a clear multi-year objective, a clear investment strategy and hiring professional portfolio managers to implement the strategy in a disciplined way, free from the common emotions that lead many investors to underperform."

Credit Suisse has also declined to disclose AUM in discretionary portfolios. But it said growth has been strong at 32 per cent year-on-year as at end- June. At DBS Private Bank, AUM in discretionary portfolios has grown more than 2.5 times over 2016.

Depending on portfolio size, banks are also able to offer customisation. At DBS, this begins for portfolios of at least S$5 million and may be based on a number of specifications, such as exclusions, ESG constraints or a particular type of instrument.

At Credit Suisse, Tan Wei Mei, head of portfolio solutions (APAC), says full customisation can be delivered in a portfolio of US$10 million. For basic exclusion, at least US$5 million in assets is needed.

Risk control is par for the course

BOS' Mr De Mello says risk is controlled through asset allocation, country/region/sector exposures and limits on duration and single securities exposures, for instance. "Our portfolios are also actively managed from a tactical asset allocation perspective, where portfolio managers react quickly to de-risk in order to preserve portfolio value in times of crisis."

At UBS, Mr Eckart says positions are monitored round-the-clock and analysts and specialists are able to respond tactically. "The ultimate risk control is in-built in the portfolio via its multi-asset diversification, and substantial allocation to hedge funds. Given that we still have a conservative outlook for risky assets, we want to be careful not to sacrifice too much upside returns by outright hedging."

Lombard takes a "core/satellite" approach that Mr Nakamura claims is a "pace-setter" in Asia. A moderate risk portfolio, for instance, is not necessarily invested 50/50 in equities and bonds. He says: "A (50/50 portfolio)'s total risk is highly skewed towards equity risk only, as it represents on average 97 per cent of the total risk. So this portfolio which looks diversified in terms of quantities is absolutely not the case in terms of risk.

"Also, the total risk (of a 50/50 portfolio) will start drifting, potentially to a very high level as soon as equity volatility starts to jump as a result of a portfolio defined by capital exposures or quantities, and not by risk proportions."

Lombard's approach disregards quantities and looks at risk or risk distribution. "A truly moderate portfolio is one with a volatility permanently close to 5 per cent whatever the market conditions, and where this risk will be fairly contributed by major assets, each representative of a specific stage of the business cycle. Such portfolios have been able to generate net excess return of roughly 5 per cent annualised since their respective inceptions."

So far, private banks claim outperformance against benchmarks. For Credit Suisse, for instance, a portfolio of 45 per cent fixed income and 55 per cent equities returned 2.56 per cent this year up to end-August, compared to the benchmark return of 0.16 per cent. BOS says its discretionary portfolios achieved a compounded growth rate of over 10 per cent over the past two years.

Positive outlook

In terms of market outlook, the banks generally continue to take a positive stance on equities. Credit Suisse's Ms Tan adds that the bank is also positive on commodities, but negative on global government bonds and neutral on credits.

Says DBS chief investment officer Hou Wey Fook: "While we are certainly cognisant of the extended US cycle, we do not see the typical late- cycle signs of overheating. Wage growth, commodity prices and inflation remain modest... Barring a full-blown trade war, which is not our base case, we continue to engage equities and credit." He adds that the Federal Reserve's policy of gradual rate increases "remains constructive of risk assets".

BOS' Mr De Mello expects the Fed to continue to raise rates by 25 basis points every quarter into 2019. US' 10-year Treasuries' yield however, is likely to be capped due to global and institutional demand. "This may result in a flat yield curve. However, unlike in previous episodes where flat yield curves were associated with heightened recession risks, this time, new monetary policies such as quantitative easing and negative interest rates in some countries have weakened this type of signal."

He adds that the firm is "turning more constructive" on emerging market assets, given their significant underperformance year-to-date. "Earlier in the year we held on to high level of cash - up to 10 to 15 per cent of cash across DPM portfolios - but are now investing in EM assets, particularly EM bonds and Asian equities."

Lombard's Mr Nakamura says that while US stocks have been the key call this year, "over the next six to 12 months we believe emerging assets have reached a level of valuation which offers a buffer even in the event of a deterioration in trade talks, while offering significant room for rebound in case of a depreciating US dollar". W