HIGHLIGHTS
“Wealth Management” Corporate Connecticut Magazine, May 2003 (L.M. Noushin)
Corporate Connecticut Magazine is a four-color glossy magazine devoted to people who make business happen in Connecticut and the region - people you would not usually find in a newspaper, news tabloid or national publication.
Wealth
Management
Harness the Power of Equity
By L.M. Noushin
The No. 1 rule is to know the difference between an asset and a liability. The rich focus on their asset columns while everyone else focuses on their income statements. The more money that goes into my asset column, the more my asset column grows. The more my assets grow, the more my cash flow grows. And as long as I keep my expenses less than the cash flow from these assets, I will grow richer, with more and more income from sources other than my physical labor.
Robert T. Kiyosaki (author of Rich Dad, Poor Dad, 129 weeks on the New York Times Best-Seller List as of February 2, 2003)
With the S&P 500 index now down more than 40 percent since its March 2000 peak, putting up your guard when it comes to investing is understandable. But, let’s look back to 1990, just before the bull’s broke lose from the coral in 1991: War with Iraq loomed, the recession raged, unemployment climbed over 7%, investors yanked their money from the stock market. Banks faced huge loses. State and local governments struggled with mounting deficits. The crime rate peaked. A tidal wave of pessimism gripped the nation. (Remember, this is 1991 not 2003.)
Suddenly, all that changed when the bulls charged in the early 1990s. The economy strengthened. Governments went from running budget deficits to running major surpluses. The stock market bounced back bigger and better than in any other time in history. 21 million jobs were created and the American psyche went from gloom to full-fledged exuberance, seemingly overnight, and probably without us much noticing.
It’s true recessions are scary, and the obvious worries about jobs and paying bills keep us all awake at night. But, let’s not overlook one very important fact: Since the end of WWII, the U.S. economy has seen 10 recessions. And has emerged from nine of them stronger than before. Of course, it's not certain yet that we'll pull ourselves out of No. 10 in better shape but, history tells us: be patient, don’t loose focus and above all, for richer or poorer, we’re all in the same boat.
The affluent too, toss and turn in the hours of darkness, worrying about how to preserve and safeguard their wealth. In fact, they worry more than us average folks. According to the HNW Wealth Pulse, a series of reports examining the wealthy by HNW, Inc., a start-up company with high profile investors (such as Henry Kravis of KKR & Co fame) that offers high-net-worth customer relationship management services to financial services institutions and companies offering luxury products and services, the wealthy are nearly twice as concerned with sustaining and increasing their wealth than the total U.S. population.
The term “millionaire” when referring to the affluent classes is now deemed irrelevant and antiquated by the market researchers who help financial service companies and luxury retailers target the wealthy. Indeed, these firms prefer to use terms such as “high-net-worth,” "pentamillionaire" and "decamillionaire." They define high net worth individuals as those who posses assets of $500,000 or more and have an annual income of at least $100,000, or a net worth of at least $1 million. Pentamillionaires or “super high net worth” people possess at least $5 million and decamillionaires, $10 million in net worth or more. There is even a term for "centimillionaire" – those whose balance sheets top $100 million in wealth. The so-called "mass affluent" (defined as those who have investable assets of $100,000 to $500,000) are not actually among the high-net-worth segment, but they are highlighted by many marketers as an important and growing segment because they are likely to move into the high-net-worth arena.
Greenwich-based NFO WorldGroup, estimates that Connecticut has nearly 9,000 pentamillionaire households with more than $5 million in assets, not counting their primary residence. More than a third live of them live in Fairfield County with about 2,000 in Hartford County, according to NFO estimates. For its population, Connecticut had the most million-dollar incomes in the nation in 2000, topping Massachusetts and New Jersey. In terms of income - not assets - the average Connecticut millionaire actually is a multimillionaire, realizing $3.8 million in income in 2000. However, their numbers across the board are dwindling as the newly rich loose their status in the millionaire’s club. NFO reports that the number of American millionaires fell by 11% in June 2002 compared to year ago. Millionaires are also less confident regarding their current financial circumstances, according to the NFO study, the 2002 Affluent Market Research Programs.
"The decline in the equity markets finally caught up with this group of investors," explains David Thompson, director of affluent market research at NFO Financial Services, a division of NFO WorldGroup. "In the early stages of the current bear market, from mid-year 2000 to mid-year 2001, the number of millionaires basically stayed the same largely due to the strength of their diverse portfolios."
However, this is shifting. The number of millionaire households fell from about 3.7 million at mid-year 2001 to 3.3 million at mid-year 2002. And, with the decline in their numbers also comes a decline in the overall financial confidence of these millionaires. The Affluent Confidence Index, a measurement of the sentiment of wealthy Americans toward their personal financial situation and of the economy as a whole over the next six months, fell from 16.2 to 15.5 in June 2002 (the latest numbers available.)
"This startling year-to-year decline in the confidence index is related to their pessimistic outlook toward their income and general financial situation," continues Thompson. "This rather dreary outlook is also reflected in a shift in some key attitudes toward investing."
Public arguments aside, the rich, with their mass of economic and social influence affect everything from the markets to philanthropy. The wealthy are not immune to the recession and most have been impacted in one way or another. Before the downturn, the rich were basically managing their returns, doling out billions to charities but not necessarily focusing on risk. All that has changed since the bears took hold. And their declines have impacted industries such as financial services who manage some $23 trillion in personal wealth.
“With equity investments, the wealth effect has turned negative, says The Advest Group, Inc. national sales manager, Bill Cholawa. “But wealth has clearly been offset by the fact that real estate has held up so well. The increase in real estate prices has neutralized the decline on the equity side and they are less likely to take calculated risks and more likely to be conservative in their investments.”
Cholawa, a 40 year-old Glastonbury resident with 15 plus years in the business, has seen the wealthy become more conservative with their money over the last several years. “It’s harder to convenience clients now that it might be the time to start looking at long-term equity investments again. We’re trying to get clients to focus on an asset allocation process instead of looking at just stocks, bonds, and money market funds. A balanced asset allocation picture is key and that’s where we’re trying to drive a lot of the process.”
Whether you have $50,000 or $25 million, it’s not easy coping with risk and volatility in a downmarket (or for that matter, in an upmarket), but the same basic principles apply. (It’s surprising how many people think the rich lean only on professional asset pros to manage their wealth without any personal guiding investment principles.) While this may be true in some cases, the majority of folks with money, need a strategy, clear objectives and a well-conceived plan, just like us average joes.
“Make sure you have a plan. Sit down with your advisor and review it yearly, preferably, quarterly,” advises Cholawa. “That plan should include the risk management side of the equation. Find out exactly how much risk you can tolerate based on your current financial situation and your future needs.” That’s always changing, adds Cholawa, based on current market conditions and the underlying factors affecting market volatility.
Building wealth demands an inordinate amount of time, resources and knowledge. That’s why the majority of affluent folks with assets of at least $5 million use wealth management advisors as their personal family CFO to guide them through the choppy waters of money management. Wealth management advisors are out of the box, finance-estate-tax gurus, who provide highly personalized and confidential services often in exchange for a hefty fee. Typically, a wealth advisor consults with only a few clients at a time and serves a vital role in overseeing the portfolios of the rich. But, multi-skilled and hüber talented, advisors do more than just protect and build wealth - they often act as confidantes, something accountants or mutual fund managers almost never do. One important upside to their big fees is their ability to juggle not only capital and asset issues but also their unique desire to help cope with the burdens (and joys) of wealth. Often, though most will never admit it, they’ll advise high-powered executives on suitable mates, assist moms-to-be in nanny selection and perhaps, most useful, just listen to the rich vent about their problems.
Since the market soured 3 years ago, these wealth advisors have been very busy working long hours to keep their clients happy (as well as, in the money), least they pack up and jump ship or worse, start loosing their accumulated wealth. Advisors, while at an all-time high several years ago, are not averse to current market conditions either and are experiencing a shake-out within their own ranks.
The industry is currently undergoing a massive downsizing. Five years ago, many leading banks and brokerages entered the sector offering one-stop services for wealth management, intensifying competition between firms. Since 2000 alone: JPMorgan Private Bank, UBS Warburg, Fidelity and other big names have aggressively expanded their wealth management businesses to get more money out of their client’s wallets. Some have recently retreated because of the decline in the equity markets and the trailing off of the nouveau rich. Those that remain have lost a lot of credibility and confidence because of today’s downmarket. Consequently, client retention has become a burning issue in the industry. Demonstrating competence and excellence to retain affluent customers is not only a function of investment performance anymore. Today's affluent investor is demanding a combination of excellence and superior service (see sidebar).
At the same time, nearly a quarter of America's wealthiest investors are telling the brokerage and banking community that "no advice is the best advice.” Twenty-one percent of millionaire investors polled by NFO decided they are better off without a financial advisor last year. Overall, America's affluent investors have given their advisors a "C" grade for mediocre performance, ability to resolve problems, and a general lack of competence in taking a leadership role in protecting and building their clients' portfolios says the study.
"A 'C' grade didn't get financial advisors into their MBA programs, and it surely will not win the trust of the wealthiest investor," observes Thompson. "In this economy, affluent investors are demanding excellence, not mediocrity, and they simply aren't getting it from the mainstream of the advisor community."
"Full-service brokers - who are traditionally the mainstay of financial advice for affluent investors - are particularly at risk of losing their most prized clients," adds Thompson. "The data suggests that very few full-service brokers have been able to differentiate themselves with creative and effective wealth preservation strategies, or deliver the personalization and incremental value that wealthy investors require. As a result, affluent Americans are looking to boutique financial specialists who may offer a narrower range of services, but instill a greater feeling of competence and confidence, or they are simply going it alone."
Even old-money folks whose most high-tech item might be a motorized yacht have changed their habits over the last several years. "Our clients have serious concerns about the market and we’re actively addressing their concerns with new tools and services," explains Cholawa of The Advest Group, Inc.. “Older people have embraced technological change, and like to access the Internet to view stock quotes, research products, trade stocks, or bank online. In the late 1990s, affluent individuals took on more of their own money management, sometimes with the help of Internet tools. The market crash has made these individuals realize that advisors often are more knowledgeable than the information they could gather on their own but clients still want access to their portfolios online with financial planning tools to keep on top of their portfolios."
Sometimes, the guidance advisors provide is no different from the standard wisdom touted on websites like the Motley Fool. "Most important is the necessity of defining a clear plan at the outset and sticking to it. We need to constantly remind our clients to stick with their plan,” says Cholawa. “That’s one of the most difficult challenges we have.” Remembering all the while that the true value of a portfolio lies in the wisdom and scope of the assets as a whole, not in the price tag of individual parts.
G. Haig Ariyan, director and branch office manager with Deutsche Bank Alex Brown in Greenwich, Conn., agrees and encourages clients “to have a clear understanding of their individual circumstances, clear objectives, and make sure their portfolio is structured to meet those objectives. At the same time, it should be protected in such a way that your not putting exposed dollars at risk that should not be at risk.”
But other aspects of advisors’ guidance are traditionally aimed solely at the wealthy. Since the economy went south, some advisors have been encouraging clients to use alternative investment classes (investments other than stocks and bonds) such as hedge funds and fund of funds when the market is going down or sideways. They offer potentially higher risk-adjusted returns, lower volatility and asset protection during difficult markets. And because of their low correlation to the public markets, they can help offset the negative impact of down markets.
Hedge funds are popular right now with wealth advisors. A hedge fund or what is sometimes called an absolute return strategy, is usually a private investment partnership invested primarily in publicly traded securities or financial derivatives. Because they are private investment partnerships, the SEC limits U.S. hedge funds to 99 participating investors, at least 65 of whom must be accredited. (Accredited investors often are defined as investors having a net worth of at least $1 million.) A relatively recent change in the law (section 3(c)7) allows certain funds to accept up to 500 qualified purchasers. In order to be able to invest in such a fund, the investor must be an individual with at least $5 million in investments or an entity with at least $25 million in investments.
The main reason hedge funds are so attractive (beyond the fact that returns are often higher than say an S&P 500 Index) is that compensation for a hedge fund manager is performance based. (Mutual funds and the like are asset-based.) The general partner of the fund usually receives 20% of the profits, in addition to a fixed management fee, usually 1% of the assets under management. That kind of money is a powerful motivator and most hedge fund managers thrive on this type of structure. Other vehicles being offered include offshore banking, an alternative strategy for protecting large amounts of wealth.
“We utilize all the asset classes of an appropriate asset allocation to minimize risk. It includes long positions in equities, long positions in fixed income and more often, we’re finding that the utilization of alternative investment classes such as hedge funds are proving valuable in lessening the risks of portfolios,” says Ariyan.
Most wealthy people often have a greater understanding of risk, unlike average folks, and are more willing to hold on to their stocks and bonds for the long run rather than cash out and avoid further losses. “The last three years have been a tremendous learning experience for everyone. Blind equity investing,” observes Ariyan “is a very risky proposition which has hurt many people. Proper planning implementation and ongoing portfolio monitoring are extremely important. You have to make sure every plan is meeting expectations. People’s financial needs are always changing so it’s important that portfolios are continually adjusted along with the clients needs.”
Choosing between the abundance of management services available (finance, estate, tax, etc.) and the glut of investment vehicles on the market (hedge funds, international bonds, off-shore shelters, etc.) can be overwhelming. Successful wealth management takes more than just finding a family CFO who you can trust. What’s strikingly clear is that the wisdom, experience and insight that goes into shaping anyone’s financial strategy should take precedence over impulsive moves. It demands hard work but with the many creative options available, the wealthy can devote less time to building wealth and more time dispersing its rewards.
Still, we’re irrational creatures when it comes to money. Best to have a plan and stick to it.
SIDEBAR
THE AFFLUENT MARKET
KEY CHARACTERISTICS AND ATTITUDES
The affluent market can be divided into six key segments, according to recent research done by LIMRA International, in Windsor, Connecticut, along with McKinsey and Company, a management consulting firm based in New York, New York. The study, “Marketing to a Dream: The Affluent Defined by their Aspirations,” by James Mitchel and Cheryl Retzloff, differentiated these segments based on the consumers’ future aspirations.
Deserving Connoisseurs. This group wants to enhance their lifestyle and live “the good life.” They have an interest in pursuing leisure and having the best in material goods. They often value having financial advisors and want to be involved in financial planning and are interested in increasing their wealth.
Family Providers. Family providers intend to leave their assets to their heirs. They hope to retire as soon as possible so they can spend time with their families. They’re interested in retirement planning and in early retirement and are less comfortable managing their own investments and are often open to working with financial advisors.
Mainstream Wealthy. These individuals want to live a comfortable lifestyle, spend time with family and continue the good life to which they’ve become accustomed. They are mostly interested in keeping what they have and tend to avoid risks and welcome assistance in financial planning.
Explorers. Explorers want to do something new after retirement, such as start a new business, try a new career or go back to school. Explorers are willing to pay more for better service. They are concerned about their financial situation at retirement, and see finances as a way of opening up their options.
Leisure Seekers. This group wants to spend more time pursuing leisure activity (such as travel or theater) and to maintain a comfortable lifestyle. Leisure seekers are often independent about finances. They are less likely to use financial advisors or buy life insurance, but are most likely to develop a financial plan during the next two years.
Work Engrossed. These people want to stay busy. They are often business owners or professionals who intend to keep working. Work engrossed individuals often do not trust advisors and rely on themselves for financial decisions. Once they come to trust an advisor, however, they tend to remain loyal. They prefer less complicated products.