In the wake of the global financial and economic crises, conditions in capital markets today are markedly different from a decade ago.

Investors’ ability to obtain a reliable return on their savings has been greatly diminished as yields on benchmark government securities have collapsed, thereby threatening prospects for their retirement income.

Stock price volatility has escalated dramatically from a decade ago, and commodity price declines have raised risks for much of corporate Canada.

Foreign exchange markets regularly undergo huge price swings, disturbing the terms of trade.

High-frequency trading now accounts for more than 50 percent of North American stock market transactions, and shorter-term asset allocation—with its emphasis on derivatives rather than on direct long-term investing in equities and bonds—has become the new normal.

Increased regulation and new technologies are challenging traditional financial services business models globally.

In this new investing world, The Analyst asked two prominent practising CFAs in the private wealth field—a category of investment for which absolute returns have always been more important than relative returns—how their activities have adapted to the sea change in their environment and what they expect for capital markets and their professions.

Nancy Hoi Bertrand, LL.B., CFA, is a Director at Citi Private Bank, specializing in ultra-high net worth clients ($25 million-plus). She has an extensive background in securities law and private banking in Canada and the U.S. She is a past president of CFA Society Toronto.

Nancy Hoi Bertrand says her advice to clients still starts with an investment strategy based on financial objectives and risk tolerances. What has changed, however, is how that strategy is executed, given the many more types of investments now available, particularly on the capital markets side.

MORE INVESTMENT CHOICES

“Although we have always engaged in hedging, many clients are implementing more sophisticated structures than simple forwards, such as collars, spreads, steepeners, and other derivative trades,” she says. “Our clients are definitely more interested in hedging left tail risk than they were 10 years ago.

Also, today, the majority of our clients have alternatives such as real estate, hedge funds, and private equity in their portfolios, which wouldn’t have been the case a decade ago. They’re also using leverage to enhance yield and generate positive carry in this low-yielding environment.”

As for how clients’ funds are managed, Bertrand says Citi Private Bank has always taken an institutional approach to money management. “We start with a quantitative and qualitative analysis of a client’s cash flow and investing needs to determine the optimal asset mix and portfolio construction. All of our clients are ultra-high net worth, which means they’re not investing for themselves but for future generations or to achieve their philanthropic goals.”

INCREASED REGULATION

Compared to a decade ago, regulation of financial services is much greater, Bertrand says. While her firm sees the value in regulation and doesn’t just meet, but rather exceeds, all requirements, frequently changing regulations require extensive resources in terms of time and effort to stay up to date on the impacts to the firm’s business and to its clients. “Citi recognizes that regulators have the best intentions, and we work within their guidelines to do our best for our clients,” she adds.

THE FINTECH CHALLENGE

Bertrand is forthcoming in identifying the competitive forces within and outside the conventional financial services industry. “We are already seeing the impact of fintech [the segment of the technology start-up scene that’s disrupting sectors such as mobile payments, money transfers, loans, fundraising, and asset management] on traditional financial services, and we’ll continue to see disruption in the industry from technology,” she says. “With our clients becoming more and more tech-savvy, I would expect to see peer-to-peer lending continue to grow, as well as increasing numbers of more sophisticated robo-advisors [providers of portfolio management services online with minimal human intervention] in wealth management.”

MUTED EQUITY RETURNS

All of this is occurring at a time when recent equity and bond returns have contracted. Bertrand expects more of the same in the medium term. “Over the next five years, I expect equity returns to be quite muted, as we’re starting to see corporate profit margin compression and a market that’s fairly valued. As for bond markets, many developed markets are already at negative interest rates, which means you’re guaranteed a loss if you hold to maturity.”

In this environment, she acknowledges that a challenge to private wealth advisors is to demonstrate that their services are superior to their competitors’ and that their fees are fully justified, even in a period of low returns.

DOWN THE ROAD

Finally, as one might expect from an astute advisor to ultra-high net worth clients, Bertrand provides some sage predictions. “Governments around the world are looking for new sources of revenue, and I think we’ll see taxes increase across the board, specifically for our clients, as it’s politically popular to tax the wealthy. Coupled with higher taxes, it will be more challenging to find attractive after-fees and after-tax opportunities, going forward, because of the macroeconomic headwinds the world is facing. As a result, many entrepreneurs may defer selling their businesses because of the tax bill and the uncertainty as to where they’re able to reinvest their sale proceeds. The statistic that, potentially, $1 trillion worth of small-business assets will change hands in the next decade in Canada may be pushed out further into the future.”

Linda Palin, MBA, CMA, CPA, CFA, is managing director and founder of Pangaea Asset Management Inc. Her professional experience includes many years as an equity analyst and as an institutional and private client portfolio manager. She is a past president of CFA Society Toronto.

Linda Palin provides financial advice and portfolio management services to a varied clientele. While performance is important, it’s not the sole criterion at Pangaea. The firm emphasizes investment philosophy (a classic valuation-based approach to long-term investing), financial planning, good communication, and sensitivity to clients’ needs and concerns.

PRIVATE (EXEMPT) INVESTMENT PRODUCTS

In recent years, Pangaea has been able to include in its clients’ portfolios both public and private investments that previously were available only to institutional investors and family-office level investors (its “hybrid” approach to portfolio management). Included among these private (exempt) investments are mortgage products, which offer enhanced returns in the context of clients’ risk profiles and return objectives.

FINANCIAL SERVICES’ FUTURE

Palin believes the financial services industry will become more fragmented in the future. “There will be disintermediation from new fintech solutions, such as robo-advisors,” she says. “And there will be upheaval from regulation such as the new Canadian Securities Administrators’ regulatory initiative known as the Client Relationship Model Phase 2 (CRM2), which mandates various new disclosure requirements to be phased in over the next few years. The impact of CRM2 on advisors in the Mutual Fund Dealers Association of Canada is already challenging the status quo. Blockchain applications (i.e., giant digitalized record books of all transactions) will strip away many of the back-office costs of investment managers, enabling them to be more nimble and profitable in providing service while freeing them from the burden of bank-dominated custodial operations.”

REGULATORY CHANGES AND LOW MARKET RETURNS

On the outlook for equity and bond returns, Palin shares Bertrand’s views. “Our expectation is that both equity and bond market returns will be lower than the norm of the past 25 years, due, partly, to lower inflation levels,” she says.

Both advisors say that keeping up-to-date on new products, issuers, and regulatory changes is a greater challenge today than it has ever been.

MILLENNIALS’ NEEDS

Virtually all private wealth advisors agree that one of the big challenges facing the financial services industry will be how to service the needs and objectives of millennials (those born between 1980 and 2000), who don’t currently have a lot of capital but will, in time, have much more.

Many private wealth advisors maintain that the best way to do so will be online, as, according to the Financial Times, almost 90 percent of millennials check their smartphones within 15 minutes of waking up. Some advisors even believe that gamification (the application of typical elements of game playing to encourage engagement with a product or service) can be effective. Michel Jacquemai—co-founder of meetinvest, an online platform modelled on fantasy football that enables users to emulate the investing styles of famous investors, past and present, such as Warren Buffett and John Templeton—says, “You just can’t retain younger clients with a piece of paper and some charts, but if you give them something to click and interact with, it retains their interest.”

The line between entertainment and serious discourse is often blurred in the investment industry by the electronic media (and it now appears to be fading in the political arena, too), so it’s easy to envisage smartphones, apps, and gamification all playing a more significant role in private wealth management in the future.

It’s a cliché that the future belongs to those who prepare for it today, but it’s no less true for that, especially in the ever-changing, hectic space where the worlds of finance and technology merge.