The Asian business success story is responsible for the region’s massive wealth creation over the last two or three generations. But whether or not the wealth can be preserved for future generations or philanthropic causes will require entirely different skill sets. For an Asian high net worth individual or a family office, managing an investment portfolio in today’s uncertain markets represents a serious challenge. Both cultural characteristics and business conditions that were responsible for their rapid success could actually prove to be severe and perhaps insurmountable disadvantages.
Andrew Hendry, Managing Director, Asia at M&G, has experienced different client requirements and backgrounds in Asia, Europe and the US. He remarked, “First and second generation Chinese family offices suffer from cultural impediments that prevent them from operating a successful investment enterprise. A new crop of them have emerged and are trying to find their way into an investment methodology that not only works, but suits their beliefs.”
HNWI and new family offices, which are often dominated by the patriarch, want to preserve and expand wealth for future generations, but ironically, they engage in activities that work against prudent and proven portfolio management policies. Behavioral finance represents the most accurate and constructive methodology to educate clients about potential pitfalls and biases.
A Matter of Character
Hendry explains, “Psychological biases, emotional reactions and shifting attitudes are a result of momentary losses and gains. Unless the client is an investment professional, most people don’t have the time or discipline for a lengthy financial analysis. So they rely on instinct and short cuts, which can turn out to be seriously wrong when they are based on stereotypes, biases and incorrect assumptions.”
“Overconfidence is the biggest problem for family offices in Asia. This is a big difference from Europe, where families have endured more historical calamity and are better focused on wealth conservation. Asian HNWIs and families take their entrepreneurial confidence into the world of investing thinking they can replicate their business confidence into investment.”
The result is often highly unbalanced portfolio allocations, which perform poorly in the long term: “Asian HNWI only place 5% to 15% of their portfolios into discretionary investment vehicles such as funds,” says Hendry. “This is very small compared to the US where delegating stock and issue selection is a more accepted practice, representing 60% to 70%. In Switzerland it is over 50%. And that’s not necessarily just for long term investing.”
Trusting Professional Advice
The repeated source of this problem is distrust of professionals by Asian clients. Hendry explains, “Rather than delegating to fund managers, Asian investors made the mistake of thinking they were saving money by gaining and demanding direct access to issues, picking new, individual issues. The underlying question is do you believe that someone knows better than me?”
Family offices don’t fare much better in establishing professional trust. Despite having more money to manage, inexperienced family offices are ironically unable to find the best active managers. These top managers don’t want to work with inexperienced family offices, who are secretive and withhold trust. Combined with an aversion to fees and lack of understanding of how asset management works, there are serious operational problems for new family offices to deal with.
These regressive and stubborn attitudes have resulted in missed returns and increased risk. “Consider the outstanding, QE-driven US equities market run. Not only have most local family offices completely missed this trend, but it has virtually destroyed the hedge fund market up until this year. Now family offices realise their clinging to fixed income and cash was a loss-making strategy. But seeking higher returns through active investing or finding active managers may be too late, as value has been squeezed out of the equity markets.”
Hendry describes how the psychological phenomena of ‘cognitive dissonance’– where human nature compels people to avoid unpleasant information, can hurt returns. “Asian portfolios look like a barbell of fear, where cash levels are 30% to 50% and because of lower confidence in the US and global stocks, they display too much home (Asian) bias.” He adds, “Too many Asian investors are still too focused on fixed income asset allocations and have missed significant value in US equities over the last five years. They basically ignored professional advice. They avoided cognitive dissonance in seeking views that made them feel comfortable. By doing so investors oscillate between the polar opposites of fear and greed.”
Placing fear and greed into an investment perspective is important for investors to understand and personally reflect upon: “Fear and greed are the psychological basis for this behaviour and explain how risk tolerance rises and falls. Risk tolerance and perception are an illusion as they are actually driven by market sentiment. That explains why it is easier to invest at the top rather than the bottom of the market.”
Second Generation Asian wealth faces Obstacles
Hendry reveals the special challenges for Asian clientele. “Although studies show that culture doesn’t necessarily change the basic elements of investment psychology aside from home bias, persuading Asian clients to move away from short term trading to systematic portfolio construction is probably the biggest educational challenge for private banks.”
Widely available data along with mobile technology has resulted in an avalanche of information that can inflict selective information bias on investors. “In Asia, the amount of conflicting and broadly available information means that an investor is highly prone to selective data that affects where he focuses his attention. Humans are especially prone to media suggestions in the short term even though they should be focused on the long term issues.”
The second Asian generation poses unique problems. “While most of them are well educated many of them lack long term investment experience. Those who worked in banks have limited and specialised financial experience that may be useful, but unrelated to portfolio management. Realistically, a portfolio manager needs at least 20 years of experience to understand how to invest through numerous economic and market cycles.”
Furthermore, when bad investment habits are allowed to persist through the first generation, it creates big problems for successors. “While Asian families want wealth to grow and most of all, ‘stay in the family’ they still flip and speculate on stock. The bad investment habits of the first generation are passed onto the second one. The next generation has no framework to move forward and sustain and grow wealth over the long term.”
The rise in the number of Chinese family investment offices is a cause for concern because they are ignoring some important lessons from the US and European experience. “Few Chinese family offices are built for rational decision making. The term and concept of family office is misused in Hong Kong. Its western and European roots imply a professionally staffed investment enterprise that is either independently managed from the main family business or numerous generations removed from the original family business.
Lessons from Europe
Hendry describes the difficult obstacles and pitfalls that European family offices and their next generation had to overcome in the late 20th century: “In Europe a generational shift occurred in the 1960s and 70s, where the appetite for investment risk increased after a conservative period from the end of the Second World War. But, without a clear set of investment principles, many family offices found their investment abilities to be severely challenged in a global environment where regulations, economies and markets rapidly changed.”
The results were sometimes disastrous. “They were wrong footed by the rapidly changing economic, market and business conditions. Some went bankrupt. European families actually struggled to find the right family office model post war and for the next generation.”
Hendry simplifies the process for cultivating a set of healthy investment principles whether you are a HNWI or family. ““The starting point to determining your investment attitude is to confront your relationship with your money. Are you focused on achieving investment objectives or exercising your ego? Investment is a function of character. This is the most difficult issue of all. Ultimately, the goal is to do a better job of investing than the man on the street.” BM