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Millionaires need downside protection, too

The risk tolerance of high-net-worth investors in North America is growing, a new study shows. But money managers say that preservation of wealth should come first

By: TERRY CAIN

Date: October 29,2014

It was author F. Scott Fitzgerald who said, “Let me tell you about the rich. They are different from you and me.” It’s a debatable point, but when it comes to investing, high-net-worth individuals may have goals and priorities that can be different from the average investor.

There isn’t a firm definition, but individuals are generally considered part of the high-net-worth category when they have investable assets in excess of $1-million. Investable assets exclude the individual’s primary residence. It’s estimated more than 4 million people fit into this category in North America alone – 320,000 of those in Canada. That’s according to the World Wealth Report, an annual study conducted by the consultant firm Cap Gemini and RBC Wealth Management.

When it comes to this group, wealth managers find that these investors often value capital preservation over capital appreciation. After all, when one is already well-to-do, the key is not to lose the money rather than trying to make the most money possible.

While this rule of thumb remains true, the latest edition of the World Wealth Report found that it is becoming less so. The report found that high-net-worth investors do slightly favour wealth preservation over wealth growth. However the difference was slim – 28.6 per cent of respondents compared with 27.6 per cent. And the gap is shrinking. The difference decreased by 4 per cent compared with the year before.

“The way I look at it is high-net-worth investors are more concerned about downside protection,” says Craig Strachan, vice-president and head of product at Fidelity Investments. “But it’s not the case with all of their money. Usually there is some portion of their money they are willing to put at risk.”

He adds that these investors typically want to look at all possible options, including alternative asset classes such as real estate and hedge funds.

David Wilson, head of the strategic analysis group at Cap Gemini Financial Services, agrees.

“Compared with the average investor, high-net-worth investors are expected to have better access to advisory services and expertise and also better access to some private and foreign market opportunities,” Mr. Wilson says. These expectations lead them to invest a slightly higher percentage of their assets in complex financial products or alternative assets such as hedge funds, private equity and real estate investment trusts, he adds.

The conclusions in the World Wealth Report back this up. In 2014 the high-net-worth investor’s allocation to alternative investments increased to 13.5 per cent from 10.1 per cent in 2013. As well, allocation outside their home market increased to 36.6 per cent in 2014 from 25 per cent in 2013.

“This trend is more relevant when the economic environment is positive,” Mr. Wilson says.

Mr. Strachan says the differences in the portfolio of high-net-worth investors may relate more to the mandate rather than asset class or philosophy. For example these clients may not necessarily seek out a money manager who simply favours value investing, but rather one who has a tendency not to recommend buying high-priced assets, plus is willing to leave money in cash, especially in times of “frothiness” in the market.

Tax strategies often have greater importance for high-net-worth investors. Mr. Strachan says they may make use of investments such as corporate class mutual funds, that defer capital gains and taxable income.

But an even bigger priority may be estate planning. Mr. Strachan likes to refer to this area as legacy management. “It’s estate planning, but also more, like aspirations for what they have,” he says. “Advisors need to understand the person.” Clients may have a charitable foundation, or simply want to make sure their children or grandchildren never have to worry about money, he says.

And on the flip side, there are important considerations for high-net-worth individuals when it comes to choosing an advisor to look after their considerable portfolios.

Mr. Strachan says the average planner may not be suited to the needs of a high-net-worth investor. He recommends carefully interviewing prospective financial advisors, asking questions such as: “How many high-net-worth clients do you have?” and “What do you do differently for them?”

“It’s like getting a contractor for a home renovation,” Mr. Strachan says. “How do you avoid the bad ones? You get referrals, talk to lots of people and it should weed out anyone with a crazy plan that doesn’t make sense.”

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