Private Wealth — Netting Rich Returns

March 9, 2009, Ethical Corporation — High net worth individuals — those who own at least $1m in financial assets — are a major source of investment worldwide. This 10-million-strong global elite has combined assets of $40tn, according to the latest annual world wealth report published by Capgemini and Merrill Lynch.

The financial crisis may have dented the numbers, but the total investible income of the world’s wealthy few remains staggering. The average high net worth individual owned $4m in financial assets at the end of 2007, while the number of emerging market-millionaires is growing. Rich private investors will not vanish any time soon.

Yet for all their combined wealth and power, the world’s richest have to date been overlooked by promoters of sustainable investment. Ethical investment specialists and campaigners have become more influential in recent years, but so far they have tended to focus on converting large institutional investors, such as insurance companies or pension funds, to their cause.

They are having some success with the big institutions, as shown by growing support for the UN Principles for Responsible Investment. More than 200 asset managers have signed up to the initiative, agreeing to align their investments with the interests of society and the environment. But private wealth remains an untapped resource for sustainable investment.

Rising demand
UN PRI executive director James Gifford says: “High net worth individuals constitute a significant part of the market and one that is sometimes overlooked by the responsible investment sector. Historically there has been a tendency to equate wealthy individuals with philanthropy, but this is increasingly a misconception.”

The handful of studies looking at the role of high net worth individuals in sustainable investment find that demand from private clients for ethical financial products is rising, but it could be better served. Research has found that low awareness and understanding of sustainability among both advisers and clients means private wealth is not yet a major source of capital for sustainable business worldwide.

Sustainable investment represent 8% of high net worth individuals’ portfolios, according to the European Social Investment Forum, an investor network, in a 2008 report. By 2012, the share is expected to grow to 12%, surpassing €1tn. In total, Eurosif estimates that there is currently €2.7tn of sustainable investment in Europe, representing 17.5% of total assets under management.

Wealth managers, high net worth individuals and their representatives agree that demand for sustainable investment is rising among the very rich. In a Eurosif survey for the report, 72% of this group said they had seen an increase in sustainable investment from wealthy private clients in the year to mid-2008, and 87% expected interest in sustainable investment to grow in the next three years, despite the current financial turmoil.

Significantly, three-quarters of family offices, which manage investments and trusts for wealthy families, said demand for sustainable investment would increase in the transfer of families’ wealth to the next generation.

A younger generation of high net worth individuals is driving the growth in demand for sustainable investment, says Eurosif executive director Matt Christensen. By younger clients, he means those aged between 30 and 55, who have either made new money, or who are starting to take a greater interest in managing family trust funds. “This generation has a different set of cultural values to their parents. An interest in sustainability is one of this group’s leitmotifs,” he says.

Emma Howard-Boyd of Jupiter Asset Management says of the new generation of private clients: “They are looking at sustainability as a concern for their investment, and see green business as an area of growth.”

Returns remain the top concern for wealthy private clients, as they are for all investors. But now younger investors are finding that they can achieve this and do good, Howard-Boyd says.

Sustainable investment funds focusing on particular themes, such as clean technology or water, are by far the most popular ethical choices for high net worth individuals. “They are easier to understand, and have had great performance,” Christensen explains. More than half of private wealth clients use themed investments as a sustainable investment strategy, according to the Eurosif survey. Positive and negative screening were less popular techniques, each being used by roughly a third of respondents.

Themed funds were an attractive entry point for clients with little or no experience of sustainable investment, according to a United Nations Environment Programme Finance Initiative study, Unlocking Value: The Scope of Environmental, Social and Governance Issues in Private Banking, published in 2007.

Project manager Remco Fischer says themed funds are popular among individuals whose investments are not big enough to influence a company’s strategy in the way a large institutional investor can. Large institutions, such as the Californian state pension funds CalPERS and CalSTRS, can take big stakes in companies and devote time to becoming active owners. “It is very difficult for private clients through their service providers to engage in active ownership,” says Fischer.

Despite wanting to make a difference through “green” funds, many high net worth individuals are not comfortable with that label. The UNEP FI report found that “ethical” or “socially responsible” investments had much broader appeal if they were framed in terms of “portfolio diversification”. Fischer says: “It’s a marketing exercise.” Wealth managers must “communicate the issues in a way that does not scare clients and makes the investment have a certain edge”. Fluffy green goals are out; strong risk-adjusted returns are in.

Obstacles
How sustainable investment products are sold to high net worth individuals is key to their uptake. At the moment, observers agree that the wealth managers, also known as relationship managers, who advise high net worth individuals on their investment strategies are not well versed in sustainability. This means they are less likely to recommend sustainable investment products to clients, even if such products exist within their own organisations.

Christensen says relationship managers in private banks have weak ties to their socially responsible investment teams — either the analysts or portfolio managers.

The introverted world of private banking means that relationship managers could miss opportunities to sell new products to clients. The failure of relationship managers to sell sustainable investment products available in-house could even be happening in organisations signed up to the UN PRI, Fischer says.

He believes there is a “communications gap” between sustainability-minded portfolio managers and researchers on one side, and more sales-oriented, client-facing teams on the other. To overcome this, he points to the training and awareness-raising work being done by Sustainable Finance Geneva, an association of investors based in the Swiss financial centre. It has started to host workshops on sustainability for private banking professionals.

Faced with disorganised wealth managers, high net worth individuals often look elsewhere for new investment opportunities. Rather than trust wealth managers, family offices tend to call each other for advice on sustainable investment options, according to the Eurosif survey. High net worth individuals source just 28% of their sustainable investment products from private wealth managers. They source 37% of their investments via private consultants or advisers, and 35% directly from investment vehicles, such as venture capital funds.

But it is possible for wealth managers to bridge this internal gap. One organisation that has done so is Bank Sarasin, a Swiss private bank with $70bn assets under management. The bank has created a team of five experts who train its 400 relationship managers in sustainability. They accompany managers when meeting private clients to help explain, and sell, sustainable investment products. The team has in part grown out of the bank’s sustainable investment research and asset management team. Head of client services and sustainable investment Erol Bilecen explains: “We simply changed focus from the factory to the front line.”

Bilecen says Sarasin’s model is unusual. In many organisations, portfolio managers and analysts double up as internal consultants to client-facing relationship managers. There is not a dedicated group to make this connection, he says. From 1 April, all of Sarasin’s private banking clients will have their investments screened against sustainability criteria, unless they opt out. Aside from shares and bonds, the bank offers clients alternative investments – in private equity funds for clean technology, and in microcredit.

Post-traumatic shift
Sarasin is clearly banking on a growing demand from high net worth individuals for sustainable investment in the coming years. Bilecen says the financial crisis has boosted demand from private clients for ethical products. “They are asking: what’s happening? How can I avoid this?” he says.

Not all agree. Jaap van den Ende, head of socially responsible investing at ING Netherlands, says: “Under current market circumstances there is not really a strong demand for anything at the moment, but clearly there is a strong interest in these kinds of products.” He adds that sustainable investments are not inherently riskier than traditional products. “Socially responsible investing provides something extra, but not extra risk.”

Individual investors tend to be more nimble than institutions, which means the financial crisis presents an opportunity for ethical investment firms, says James Gifford of the PRI. He says: “High net worth individuals tend to have the flexibility to change investment strategies more quickly than other market players and often act as trendsetters, so I think increased engagement with them can have big benefits for responsible investment as a whole.”

Yet before investment houses are able to take this opportunity, they will have to bring sustainable investment and relationship managers together in-house. Only then will asset managers – even the ones who publicly state their commitment to responsible investment – be able to tap the rich resource of funds on offer from wealthy individuals.

A moneyed elite

* At the start of 2008, 10.1 million individuals worldwide held at least $1m in financial assets.
* Their combined wealth was $40.7tn, a 9.4% gain on the previous year.
* They each had on average $4m to invest.
* India, China and Brazil had highest growth in numbers of high net worth individuals.
* High net worth financial wealth was projected to reach $59.1tn by 2012, advancing at an annual growth rate of 7.7%.

Source: World Wealth Report 2008, Capgemini and Merrill Lynch