The following article first appeared in the September 2008 edition of AsianInvestor magazine. Each month we offer online a feature from the magazine. To subscribe for more in-depth industry analysis that you canÆt find on our website, please send an e-mail to: [email protected]

Gone are the days when simple asset allocation was the foundation of the advice given by private bankers to their clients in Asia. Now, the norm is to identify investment themes and get exposure to these themes through specific asset classes or product types.

The number of high-net-worth individuals (HNWI) in Asia-Pacific rose 9% to 2.8 million last year, according to Merrill Lynch and consulting firm Capgemini. The wealth of these people rose 13% to $9.5 trillion, and is expected to reach $13.9 billion by 2012.

Asia was home to some of the worldÆs fastest-growing HNWI markets by population, taking five spots out of the global top 10 for the third consecutive year. India was the worldÆs fastest-growing HNWI market with a 23% gain to 123,000, followed by China with a 20% increase to 415,000. China also surpassed France as the fifth-largest HNWI population in the world.

The ranks of the rich also grew briskly in South Korea, Indonesia, Singapore and Hong Kong.

The World Wealth Report shows that AsiaÆs wealthy shifted their assets to cash, deposits, and fixed-income securities last year, and private bankers say this trend remains intact.

ôYou could say that greed has disappeared and fear has become the predominant driver of behaviour,ö says Michael Benz, Hong Kong-based regional head of products and services for Asia-Pacific at UBS Wealth Management.

Like many investors, private-banking clients have moved away from equities-related instruments or are very cautious with the way they handle them. In some cases, they continue to suffer from situations from which they cannot exit from equities, largely because they are reluctant to cut losses. Those that are still adding exposure to equities are doing so mainly through exchange-traded funds, mutual funds and structured products. The move out of equities has led to stronger demand for interest rate-, credit, foreign exchange-, and commodities-related investments.

Investors are generally risk averse and are more interested in portfolios and products with low volatility.

ôThis can either be a portfolio with a high degree of diversification or products with partial or full capital protection,ö says Christian Senn, Singapore-based head of investment solutions for Southeast Asia and Australasia at Credit Suisse Private Banking. ôThe main objective is wealth preservation, which in an environment of low interest rates and rising inflation can be more challenging to the investor.ö

It is amid this uncertain and volatile environment that private bankers are encouraging their clients to look at investment themes. The argument is there is money to be made even under dire circumstances.

Inflation is the predominant investment theme in Asia at the moment, and private bankers have been on the prowl for ways by which their clients can beat rising consumer prices and profit from it.

ôWe tend to be guided more by what will worry clients, and what is really worrying them now is slowing growth and rising inflation,ö says Jennifer Tay, Singapore-based head of portfolio counselling for Asia-Pacific at Citi Private Bank.

Investing in real assets makes sense in this environment, Tay says, because they will hold their value over time. The best way to get exposure to real assets, she says, is through hedge funds and private-equity portfolios. Citi private bankers prefer to recommend a suite of commodities hedge funds instead of long-only funds that invest in commodities, for example.

Deutsche Bank Private Wealth Management recommends soft commodities in particular. Another way to gain exposure to the inflation theme in the commodity space is to invest in markets of commodity-producing countries, says Anurag Mahesh, Singapore-based head of global investments and sales for Asia-Pacific at Deutsche Bank Private Wealth Management. Within the emerging markets space, Brazil, Eastern Europe and Russia are net commodity exporters.

Inflation also affects bond yields and thus, reducing fixed-income durations in bond portfolios while benefiting from the increased credit spread has also been a strategy that Deutsche BankÆs private bankers have been recommending to its clients for some time.

SG Private Banking suggests getting exposure to the inflation theme through structured products and inflation-linked bonds.

Inflation-linked bond funds are among the innovative products worth looking at, private bankers say. Fund houses such as DWS and Sinopia Asset Management have been active selling such funds to private-banking distributors.

One problem with many of these funds, however, is they donÆt have the minimum three-year track record that private bankers tend to require. Fund houses are rushing out ælinkersÆ to meet the current need but private banks may prefer to go to those firms with longstanding capabilities in this area û to firms that specialized in inflation-linked bond funds long before most investors were concerned by price rises.

Investing in distressed assets is another theme private bankers are serving up to their clients. There are several ways to participate in the distressed asset space: investing in bonds and loans trading at distressed levels; investing in stocks of companies highly affected by market developments such as the subprime crisis; or investing in active managers through hedge funds. Most of the opportunities in distressed assets are still in the US and Europe because thatÆs where most of the deals are originating from and thatÆs where most of the expertise of managers resides.

ôWe also look at distressed assets because in an environment where you have slowing growth, rising defaults, and people losing their jobs, banks provide less liquidity,ö says Citi Private BankÆs Tay. ôThe opportunities in distressed assets lie mainly in the areas of managers who focus on shorting credits, and purchasing bank debt, corporate debt and securities. These opportunities will increase as the economy slows further and liquidity continues to dry up.ö

Citi Private Bank tends to focus on distressed real assets and distressed financial assets that are being unloaded by financial institutions such as banks and securities firms where liquidity is required but fundamentals are still sound. Citi tends to focus on managers with track records of 15 years or so.

Having a good relationship with managers of distressed assets is a must, says Tan Sing-Hwee, regional CIO at SG Private Banking Asia-Pacific, because investing in this area requires very specific skill sets and the ability to buy assets in bulk.

ôDistressed fund managers are specialists. You cannot just do it yourself because you have to buy the assets in blocks, in the millions of dollars. You need people who are connected and will be able to get the best deals,ö Tan says.

Credit Suisse Private Banking offers a focused fund-of-hedge fund solution profiting from value opportunities as well as bankruptcy workouts, capital structure dislocations, rescue financing and private lending, and subprime mortgage assets.

ôBecause of their volatility, mark-to-market and liquidity characteristics, investing in such funds should only be done by investors with a medium- to long-term horizon allocating a smaller percentage of the overall portfolio,ö says Credit Suisse Private BankingÆs Senn.

A large part of product selection is done in the headquarters of private banks, but the contribution of Asian offices in choosing what to offer their clients has expanded.

In the case of Deutsche Bank Private Wealth Management, for example, the selection of managed products û since there is much more due diligence needed to be performed on the manager, management style and track record û is done centrally out of Europe. When there are no manager discretionary elements involved, selection is done typically in Hong Kong and Singapore.

At Citi Private Bank, product selection used to be centrally done out of New York and London. But the Asian team has increasingly been helping originate managers from the region.

Gaining access to successful managers û particularly in alternative investments û is a major challenge for private bankers.

ôGenerally speaking, there is a dearth of credible Asia-focused hedge fund managers, compared with those who invest in the US and Europe, and many have relatively short track records,ö says Citi Private BankÆs Tay.

Bringing on board a new, standalone hedge fund would be difficult because Citi Private Bank û like its competitors û typically requires at least a three-year track record.

The hunt for new managers, portfolios, and products will continue to be the key challenge for private bankers because the need for diversification has become more evident over the past year. And thanks to this need for greater diversification, the importance of private bankers has become more pronounced as well.

ôA lot of activity has centred on restructuring portfolios to add diversification,ö says UBS Wealth ManagementÆs Benz. ôThe need and demand for advice have increased significantly.ö