The traditional approach to private wealth management is misguided, according to research published by EDHEC.

The results of the EDHEC-Risk study* suggest the extension of portfolio optimisation techniques used by institutional investors can be used for private wealth management. This is because the techniques used in the portfolio construction are investor specific, geared for an individual's exact context, objectives and horizon.

Most private bankers tend to promote an asset liability management (ALM) approach to wealth management.

Although they claim this covers the investor's goals and constraints, the technical tools used are often inappropriate and do not give clients any insight about risk, claimed the report.

According to EDHEC-Risk, while the private client is usually asked many questions about current situation, goals, preferences, constraints and other factors, the resulting service and product offering comes down to a rather basic classification in terms of risk profiles with no link to the recommendation.

In the report EDHEC provides a formal framework suggesting that asset-liability management can ensure that private wealth managers are able to offer their clients investment programmes and asset allocation advice that improve the probability of meeting their individual objectives.

The EDHEC analysis shows that taking an ALM approach to private wealth management generates two main benefits. One is it has a direct impact on the selection of asset classes, leading to a focus on the liability-hedging and goal-specific properties of various asset classes. This focus would be absent from an asset-only perspective.

Second, it leads to defining risk and return in relative rather than absolute terms with the liability portfolio used as a benchmark.

This is a critical improvement on asset-only asset allocation models, concluded the report. These models fail to recognise that changes to asset values should be analysed in comparison to changes in liability values.

The study was produced by EDHEC-Risk as part of the ORTEC Finance Private ALM research chair.

EDHEC-Risk was set up in 2001 to conduct academic research in risk and asset management and highlight its applications to the industry.

ORTEC Finance is a global provider of solutions for comprehensive risk/return management for pension funds, insurance companies and asset managers.

* "Asset-Liability Management in Private Wealth Management," by Noël Amenc, Lionel Martellini, Vincent Milhau and Volker Ziemann.