How the wealthy invest

By Kris Vogelsong, Private Portfolio Managers

If you are fortunate enough to be a part of Australia's growing wealthy fraternity you are likely to take a different approach toward investing. Like any other investors, the wealthy's goals are centred around producing attractive returns. But significant wealth can change perspectives, methods and objectives when making and managing investments.

Wealthy investors also have the advantage of being able to pursue optimum investment outcomes. This article looks at some of the dynamics driving the practices of wealthy investors.

Time horizon

Most investors aim to accumulate enough wealth in order to draw down investments to provide for their retirement and leave something for their family. As the wealthy can generally live on the returns generated from their investments and business interests, there is no requirement to draw down on funds throughout retirement. This creates a multi-generational approach to investment, as the majority of their wealth will be passed on to the next generation and there is a heightened focus on the reliability of income to maintain lifestyle.

The ability to take a very long-term perspective means investment strategy and asset allocation do not necessarily become more conservative over time. Capital preservation efforts are focused on the long term rather than attempting to navigate every turn in the markets.

Many wealthy families adopt an "intrinsic value" approach to investment, looking to purchase quality assets that may not be fully priced by current market conditions. Warren Buffet and John Templeton are prominent equity investors who have applied this approach.

Tax considerations

Australia's taxation system creates powerful incentives to focus on tax considerations, specifically our high marginal tax rates combined with the attractive concessions available through the superannuation and imputation systems. As tax is likely to be the largest expense for any successful investor, it is a key consideration for wealthy investors who are invariably in the highest tax bracket.

Some academic studies suggest adopting an after-tax approach can add 2 per cent or more to investment returns. This focus on taxation translates into an array of implications around investment strategy, cash flow management, holding structures, and the tax efficiency of investment products. Those who are effective in their efforts to manage tax can produce far superior returns without incurring any additional risk.

Investment philosophy

Like other investors, wealthy families' investment philosophies are largely driven by their prior experiences about what has proven successful; there are no clear preferences around parameters such as growth versus value. International assets are growing in popularity but the majority of investments by most wealthy families remain in Australia.

Capital preservation is an important objective, with the primary goal of avoiding a permanent loss of capital through the forced sale of an asset at the wrong time. This often means maintaining the flexibility to prevent loss crystallisation.

A key difference between wealthy investors and the general investing public is a greater appreciation of the differences between investment and speculation. Although wealthy investors certainly engage in speculation, they generally understand and conceptualise their funds as either investment or speculation, whereas many investors make little distinction between the two.

Good investment management

Because they invest large sums, wealthy investors have the luxury of utilising any investment management product or service best suited to their purpose. Generally, this means they are looking for high value adding and/or low expenses. Mainstream products such as managed funds from big-brand fund managers attract little attention as the returns largely mimic much less costly index products such as exchange-traded products.

For active management, boutique investment managers and specialist services are used. They have a much greater capacity to outperform the market because they do not have the investment constraints of large investment houses. Structurally, Individually Managed Accounts (IMAs) are favoured for their tax efficiency, transparency and the beneficial characteristics of direct share ownership.

Different asset allocation methods

Traditional asset allocation methods are often given less significance by the wealthy, particularly by first-generation wealth creators, who are often comfortable holding significant portions of their wealth in the area where it was created, or in totally avoiding one or more of the major asset classes.

Second and subsequent generations take a somewhat more conventional approach, although their asset allocation is often very different to the model allocations and they often still maintain significant holdings in the industry that created their wealth. Property, equities and cash are the most popular asset classes, although every class has supporters among the wealthy.

Many wealthy investors allocate investment based on "buckets" for different purposes. These buckets can include wealth preservation, income generation, opportunism/speculation, philanthropy, and lifestyle investments such as art or classic automobiles.

Exotic structures not really that common

Tax-haven accounts and exotic holding structures are much less common than might be assumed from reading the popular media. While expert accounting and legal advice undoubtedly plays a significant role in the affairs of the wealthy, at the highest level the structures are easily understood.

The Self-Managed Super Fund (SMSF) has become almost ubiquitous for its tax, asset protection, and estate-planning advantages, although recent changes to contribution rules mean accumulating large sums in an SMSF structure is far more difficult than it once was.

Similarly, the family trust is used to efficiently pass assets between family generations and manage a range of family succession and control issues. More recently, Private Ancillary Funds (PAFs) have become very popular among families with philanthropic objectives. These have attracted more than $2 billion in recent years and enable a family to control its giving activities through a structure similar to a self-managed super fund.

About the author

This article by Kris Vogelsong, head of corporate development at Private Portfolio Managers (PPM), is based on a recent paper, Investment Management for Family Wealthy, available for download from the PPM Website.

From ASX

Self-Managed Super Funds has information about the features, benefits and risks of SMSFs.