As Switzerland confronts a world that is intolerant of its traditional bank secrecy, the financial sector must toil much harder to win custom. With one of the oldest banks, an approach that starts with risk is how it adds that all-important value.

As Switzerland confronts a world that is intolerant of its traditional bank secrecy, its financial sector must toil much harder to win custom. And with one of the Alpine state's oldest banks, an approach that starts with risk is how it adds that all-important value.

At Lombard Odier Darier Hentsch, with total assets under management of SFr142 billion ($145 billion) at end December 2011, the bank is devoting several billions of this AuM sum towards a “risk-budgeted” approach in managing client money. Specifically, rather than start a client conversation by asking about the returns a client needs or wants, the firm looks at the overall amount of risk tolerance a client has – or, his or her “budget” of risk.

This publication recently sat down in the firm's offices in London with Frédéric Rochat, who leads the group’s European private client activities and is one of the bank’s eight managing partners.

“Our investment offering has been totally revamped over the last three to four years. It has been designed, built and tested to deal with a very volatile environment. 2008 was a big wake-up call for the industry,” Rochat, a native of Switzerland, said.

“The majority of the industry looks at target returns; people look at asset classes; most banks will have a chief investment officer and take views on markets; there will be an investment committee from which they get the asset allocation and a lot of performance-chasing goes on,” he continued.

“The problem is that if you look at balanced portfolios over the last 15 years, asset classes haven’t delivered the returns expected. You see portfolios with equities – people will be bullish on the market…asset allocations have a tendency to lag the market,” he said.

“There is a lot of lagging in terms of increasing the equity allocation. As a result, the portfolio may be exposed to drawdowns at times of market stress. Such drawdowns have been the single biggest killer of performance within balanced portfolios, across the industry, over the last 10 to 15 years,” he said.

To illustrate the point, Rochat pointed to a graph showing how returns have fared under a “risk budget” approach and compared this with a more conventional balanced portfolio of stocks and bonds. In the former, the end result is more gains. Because there is not such a massive drawdown – as there was in one period – the benefit of compounded returns is evident. As he repeatedly says, drawdowns are the killer of long-term performance.

A different process

Lombard Odier has a different process, he said. Firstly, instead of talking about target returns, the firm talks about risk. “We prefer to engage with clients in talking about their tolerance for risk…we have a risk budget.” Secondly, instead of asking about preferred asset classes, the firm looks at the underlying sources of returns and then gets to its asset allocation (such sources as illiquid strategies, conviction strategies and passive index returns).

With passive investments, a crucial issue is ensuring that an index being tracked is genuinely diversified, as there can be distortions in indexes skewed by the market capitalisation of its component parts.

“We believe in a reactive, dynamic asset allocation process,” Rochat said.

“If we measure that equity risk is decreasing, we are prepared to raise exposure to equities,” he said, and the converse is also the case. In this way, the overall risk exposure in a portfolio is held constant.

“We are not saying that Lombard Odier will systematically outperform the more traditional portfolios (an index) but say that we do better over the course of the economic cycle,” said Rochat.

The distinctive approach taken by the firm is important in giving it an edge with clients in the international market, he said. Clients of this approach include pensions, charities, endowments and sovereign wealth funds, as well as private clients and families, he said.

A drawback of the approach is that, in the eyes of clients with a short-term, trading perspective, it will not appear to be immediately lucrative, he said. but in the longer run, it will deliver better returns for its investors, Rochat continued.

Background

Rochat is a relative newcomer to the bank, joining in October 2010 to assume responsibility for its London office.

The, at times, complex world of “risk budgets” and other financial terms is no mystery to a man who spent the first part of his career working for the investment banking arm of Goldman Sachs. He worked in London and New York, initially as an advisor to financial institutions, then to industrial companies. In this capacity, he worked for a number of large banks, insurers, asset managers and other financial services firms, on topics related to asset hedging, financing, equity recapitalisation, debt restructuring, and mergers and acquisitions.

Liability

Lombard Odier Darier Hentsch is one of the golden oldies of the Swiss banking world, operating under the unlimited liability partnership structure that is in stark contrast to the models of a UBS, Citigroup or a Barclays.

Rochat says this traditional business model has considerable benefits.

“It's the old-fashioned way of banking and means that there is an alignment of interests between the firm and its clients, particularly when there is a lot of negative news about banking at the moment,” he said.  

“Clients can meet the owners and see the owner has a very strong stake in being prudent in how assets are managed,” Rochat said.

Rochat talked about how the Swiss firm is focused on expanding its international presence for domestic clients, promoting its institutional investment offering and processes.

“Because London as a location benefits from an overlap of these elements (client presence, investment skills), London has become our biggest office in terms of headcount outside of Switzerland,” he said.

“We can afford to take a long-term view,” he said. A privately-held bank does not face the pressures that apply to a quoted firm of answering to shareholders or having to show quarterly earnings.

“Trust takes time to be built and cannot be done in three months or so. We measure success in our ability to transition clients from generation to another. It has forced us to do what we really do well, which is managing the wealth of private and institutional clients. We have never wanted to be in wholesale banking, investment banking or proprietary trading,” he said.

Rochat said the bank had twice the capital buffer as required by the Swiss rules, which are already more exacting than the international Basel requirements. In other words, its capital ratio is over 20 per cent. The bank has a AA- rating from Fitch, the highest possible rating for a bank of Lombard Odier's size.