Balancing performance against risks

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As head of portfolio management within the Private Banking Divison of Julius Bär, Lutz Welge is facing a constant challenge to source reliable investment strategies for his clients,  which range from semi-institutionals to foundations, churches and wealthy individuals.

As such, they have little interest to participate in the ups and downs of markets, instead, their key interest tends to be capital preservation. Consequently, the team has abandoned the benchmark a couple of years ago.”

“We have seen growing demand among our clients to limit downside risks,not just because of the credit crisis, we therefore decided to abandon the benchmarks, because the problem with the classical approach  is that clients don’t just participate in the upturns, but also in downturns.”

”Because most of our clients are focused on wealth preservation, the clients real benchmark is the zero-line” he explains. Nevertheless, the team still handles maximum boundaries, for example a limit of 60% stocks within a balanced portfolio. ”The benefit of of our independence from benchmarks is that we are not just reactive, but proactive and in times of volatility, such as in 2012, we temporarily halved equity exposure.”

About 75% of the team’s portfolio consists of direct investments in stocks and bonds, the remainder is invested in funds. As Julius Bär does not have an asset management or investment banking division, the team fund selection process is exclusively focused on third party funds.

”Within European and American markets, we tend to conduct direct investments in stocks whereas we prefer to gain exposure to other markets , for example Asia by investing in funds. When it comes to sectors , we are also making use of ETF’s because they allow us to reduce our exposure relatively quickly.  In general, we tend to place emphasis on actively managed funds, the key for us is really to gain alpha compared to direct investments in stocks” he explains.

”Because we actively navigate the asset allocation ourselves, the manager can’t be completely unconstrained, otherwise it would create a double-effect, therefore the manager should have a certain tracking error. We select high-performers based on a quantitative screening process and establish maximum draw downs for the individual asset classes and regions.”

Following the quantitative stage, Welge’s team focuses on direct interviews with fund managers. ”Many selectors tend to focus exclusively on performance, in our case, performance and risks are equally weighted” Welge stresses.

”We take a close look how the fund manager responds to changing market environments and assess the consistency of his investment strategy.” Once the team has established trust in a manager, it does allow a bit of time and accepts it if a fund has a bad year, as long as transparency is warranted Welge says.

Going forward, he predicts that the current paradigm shift from bonds to equities will continue to prevail, making his focus on risk management all the more challenging.  I think that there will be an even bigger demand for stocks due to the zero interest environment. If equities become unrivaled, investors will have to cope with a certain level of volatility.” Nevertheless, he remains confident: ”We have proven in the past that we tend to cope particularly well in a challenging market environment” he concludes.

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