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We high-five when we save one basis point for our clients

Stephen Katzenellenbogen on asset allocation, building a balanced portfolio, NFB’s fee structure and making cost savings for clients.

RYK VAN NIEKERK: Welcome to this Financial Advisor podcast: our weekly podcast where I speak to leading financial advisors. My guest today is Stephen Katzenellenbogen, an executive director of NFB Financial Services Group. He has been in the industry for 12 years, he has a BCom Honours in investment management, as well as a post-graduate diploma in financial planning. Stephen, welcome to the Moneyweb studio.

We live in extremely interesting economic and political times, not only in South Africa but all over the world. How does an academic qualification prepare you for this, or do you need the grey hair?

STEPHEN KATZENELLENBOGEN: I think it is a bit of both. Obviously the academic qualification gives you the right groundwork and the understanding of what we’re up to and what’s going on but I think the grey is also important because it’s exponential – you’ve got to have your nose broken once or twice. We all go through different market cycles and have different experiences and different clients, because in our industry in times like this it’s not only markets that you have to deal with, but it’s also clients’ emotions and it’s important to understand both and how they blend and marry together.

RYK VAN NIEKERK: For example, today we are seeing a much stronger dollar and consequently a weaker rand and this is all to do with Janet Yellen: her strategy to push up interest rates is gaining momentum and this could fundamentally change the world market – especially if you look at emerging markets – there could be a marked impact. Will this affect the advice you give to your clients?

STEPHEN KATZENELLENBOGEN: I don’t think it will impact the advice, but I think what it will do is impact clients’ perceptions or, even more so, their actions in terms of what they’re up to. There’s always been talk of a weaker dollar from the US and wrongly or rightly I have always thought that I’m not quite sure how that can happen in a rising interest rate environment in the US, where that’s likely to attract flows and all sorts to the currency. For a long time we and most advisors out there have been supporting getting portfolios well balanced and well diversified between your local and global assets, so I don’t think our advice is going to change there – getting clients their correct tactical asset allocations. But I’m quite certain that we’ll find clients who are lining themselves up for international transactions or they’re externalising their funds and they make just put the handbrake on for the moment while watching what’s going to happen with the currency. So, again, our job is trying to ascertain what the need and objectives are and – while it’s a big move, 50 cents does make a huge difference … when converting to dollars – is that 3% or 4% going to actually matter in eight, nine, ten or 15 years?

Advisors in the NFB team

RYK VAN NIEKERK: How many advisors are there within NFB?

STEPHEN KATZENELLENBOGEN: There are about 20 of us; so we have an advisor structure with some paraplanners sitting underneath that.

RYK VAN NIEKERK: How do you communicate? Obviously you will take a house view on what will happen and how that will impact the asset allocation. How does that communication process work?

STEPHEN KATZENELLENBOGEN: We’re fortunate in that we have a number of tentacles in our business: so we sit weekly with our asset management business, as well as our securities business to understand where they are and what they are thinking. We also sit together as advisors either weekly or definitely every second week to discuss what we’re thinking and what our clients are thinking and what the best advice is in that environment. Again we are fortunate that due to our scale we have a lot of input from the institutions and we can get a take on what they are seeing and what they are feeling, where their flows are coming from, what their asset managers are thinking and build our advice around that. But our principle overall is to be diversified and probably a little bit more cautious.

RYK VAN NIEKERK: That seems to be the theme, but what are your asset managers advising your guys? Maybe be conservative, have a bit more money in cash – you get a guaranteed 7%, 8%, which I don’t think the equity markets will do in the short term. Is that the thinking within the group?

STEPHEN KATZENELLENBOGEN: We try not to forecast or we don’t forecast, but if you had to look at our own managed solutions they are underweight there – their long-term equity parameters or boundaries. So I think that would say they are a little cautious.

I think there are probably opportunities at the moment in the local equity market, although there’s definitely earnings risk and political risk around those.

As you say, in the current environment to have a little bit of cash or income-type funds does make sense, but I think it’s quite investor specific. If you have to take a marginal taxpayer earning eight there’s not that much left on the table afterwards, so the argument could come in for some good equity with good dividend flow and it’s not too hard to get back into that same net position.

Asset allocation

RYK VAN NIEKERK: Currently asset allocation is critical, as maybe on the JSE stock picking is critical. What is your thinking around asset allocation and do you take that decision yourself, get involved in asset allocation on behalf of your clients or do you leave it to the fund managers?

STEPHEN KATZENELLENBOGEN: It’s not an all or one scenario. Depending on the client’s risk profile, needs, cash flow and all the various bits that go into financial planning, we’ll work out a risk profile or sometimes risk profiles, because you may have multiple risk profiles within one client portfolio and from then on we will often pass that onto the portfolio managers. Very often we will use flexible mandates as a big chunk of the portfolio, where those managers can shift and move between asset classes, currencies and so on within the given risk profile.

Offshore investments

RYK VAN NIEKERK: Within the international equity environment within the last few months or 18 months or so, the local market has been pretty much a dog and many people have been advised to take money offshore. But unfortunately the international markets are pretty expensive at the moment, so in many ways it’s only a rand hedge. What is your thinking regarding offshore investments?

STEPHEN KATZENELLENBOGEN: Broadly I think it should form part of all portfolios. So I think you’ve got your strategic and your tactical allocations and your strategic asset allocation means you should have part of your portfolio offshore for almost all investors. The market offshore is still quite difficult – as you mentioned you can get 8% or 8.5% in cash here, and you’re not going to get anywhere near that offshore, even in a current rising interest rate environment. But while the markets are expensive there, I don’t think they’re particularly expensive. So they’re stretched but not overstretched perhaps and our sense is that there still are opportunities there but perhaps opportunities with a little bit more caution than we have seen. My understanding [from] chatting to the guys at the securities business that we’re associated with, is that some of these offshore equities are linked to the interest rate cycle in the US and that’s going to add some extra risk to the valuations where we are seeing them now.

Building a well-balanced portfolio

RYK VAN NIEKERK: There are some advisors who say ‘take as much as you can offshore’. There’s massive political risk, at least when you have money offshore and even if it doesn’t perform as well as it could in South Africa the decreased risk is the real benefit’. Do you agree with that?

STEPHEN KATZENELLENBOGEN: Again, probably half and half. I think within reason it makes sense to diversify. If we were going to put our money offshore in cash and earn, let’s call it, zero or maybe 0.5% and we could get 8.5% here, are we going to lose more than 8% on the rand for the next couple of years? I’m not sure. We’ve all been caught probably on the wrong side of any rand calls in the last short while. So, again, I think it just comes back to a well- diversified, well-balanced portfolio.

For some clients they maybe can afford to take all their money offshore, whereas some clients who have a smaller portfolio and are going to live in South Africa and retire in South Africa can afford to have a bit more here. We still do have good companies, while it’s difficult at the moment to separate the political from the economics we still do have good businesses here that are worth looking at.

RYK VAN NIEKERK: What we do see currently is a very negative mindset from especially the middle class. We don’t like what we see politically in South Africa and South Africans are emotional people and I would imagine your clients are predominantly South African. Do they contact you or interact with you? Because in this negative mindset you get a lot of emotion and sometimes when there’s a lot of emotion around you make bad decisions. Do you see that?

STEPHEN KATZENELLENBOGEN: We do see that and it comes right back to the beginning of our conversation when we were talking about grey hairs and it’s the ability to manage that. So we try to communicate with our clients regularly through individual portfolio updates, through newsletters, newsflashes and so on because I think it’s important to understand what’s going on.

We’ve seen it all too often that rash decisions or emotional decisions often end in bad results.

I can’t remember the numbers exactly, but there have been studies done on the S&P 500 in terms of the long-term annualised return of that index versus the long-term annualised return of individual investors. That of the index is about double that of the actual investors in it because of those emotionally-driven decisions.

RYK VAN NIEKERK: Do investors or your clients actually get involved? Do you get those phone calls, or is there a bit of an agnostic attitude?

STEPHEN KATZENELLENBOGEN: We have a good blend amongst our clients. We do get people phoning in and that’s what happens when you are dealing with people. They have different concerns: some may be currency, some may be equity markets, some may even be the credit risk of cash in the bank, when you hear a headline about perhaps a bank involved in these alleged foreign currency scandals and so on.

NFB funds

RYK VAN NIEKERK: NFB also offers asset management services. Are you compelled to use those services or those trusts or funds they manage?

STEPHEN KATZENELLENBOGEN: We aren’t compelled; we are completely independent in our advisory business. It’s a discreet and separate entity. I think from the statistics or the percentage I think only about 40% of our business goes into our own solutions. But, with that said, our own solutions have done exceptionally well, walking away and being nominated for some nice industry awards this year, so they are good solutions and we are an advisory-driven business and the guys are very firm about not suggesting or recommending something where there isn’t a fundamental investment case or investment buyers for that. So just as our asset managers perform due diligence on external funds they also perform due diligence on their own funds to make sure that they go through the same rigour to enjoy access to our preferred fund list.

RYK VAN NIEKERK: Who is on that preferred fund list?

STEPHEN KATZENELLENBOGEN: I can’t remember all the names offhand, but our philosophy has typically been to stick with some of the bigger houses. We’ve got good access in terms of communication [and] pricing. I think investment risk is enough and I’m not for a moment saying that smaller businesses carry additional risk, but they may and for the time being we steer away from a lot of that. So it’s a lot of the household names. Our own funds are under the NFB brand: the likes of Prudential, Coronation, Allan Gray, also some tracker components in there, some of the DBX trackers and so on.

RYK VAN NIEKERK: There are many of these so-called boutique asset managers and some of them perform excellently – so do you try to shy away just based on their size?

STEPHEN KATZENELLENBOGEN: Not just on their size – there are a whole lot of criteria that goes into the due diligence. I’m not part of that business so I don’t know the full extent of it, but size is something important to us.

Firstly, from an investor risk perspective there’s no point in us investing 0.5% of an investor’s assets in a particular fund, because to try and manage and maintain that risk is very difficult for us. So if we want to try to have a reasonable allocation – which also drives through good pricing – we then run the risk of being too big a portion of that particular fund and that has risks on its own, if we want to change from one manager to another – which we don’t do too often, but the possibility is there. We’ve also seen that when some of these managers perform well they take on heaps of cash and it’s a different environment that they have to learn to manage in and get familiar with (that type of cash flow), where it may not have been a ‘problem’ before.

Asset-based fees

RYK VAN NIEKERK: Fees, what is your fee structure?

STEPHEN KATZENELLENBOGEN: From an advisory perspective we have asset-based fees, so our fees are linked to the size of the assets.

RYK VAN NIEKERK: What is that percentage?

STEPHEN KATZENELLENBOGEN: It varies from client to client. But we believe in a couple of things. Firstly we are very fee conscious and if you ever come around to our office we literally high-five when we can save one basis point for our clients and whenever we are able to enjoy cost saving we push those directly through to the clients. We are very cognizant of the fact that if you can save 0.5%, your return is immediately enhanced by 0.5%. A business like ours has been able to thrive for in excess of 32 years by retaining clients and you retain clients by being two things and that’s fair and transparent.

Our clients, like any others in an independent business, have the choice to remain with us or not and they have a choice to pay those fees or not, but it’s critically important for us that we know what they are and that the clients know what they are. It’s coming more and more to the fore at the moment, probably on two fronts: your effective and your cost reporting is bringing those out and I think index funds or passive investing is bringing out a focus on costs. Again, out business isn’t for or against those things, we believe in inclusion or possible inclusion in board portfolios, but I always steer investors away from making a cost-based decision, as opposed to a return-based decision, where you need to have harmony between those two things.

Just because something is cheap doesn’t necessarily mean it is going to give you a good return.

RYK VAN NIEKERK: Do you have a fixed fee option, especially when you provide the initial financial plan?

STEPHEN KATZENELLENBOGEN: We don’t. From our side we refer to it as almost risk-based advice in that we are comfortable and relatively comfortable in the advice that we give, so we are happy to give those initial proposals, discussions, planning to clients for them to have a look at and then decide without committing.

There are always pros and cons to things. Sometimes if someone pays for something they may feel obliged to do it even though it’s not 100% the correct thing. We know that people can do it themselves but – I’ve used the word ‘fortunate’ a few times – and we are fortunate that we have a big business and because of that we understand costs and fees very well, and we are able to access fund classes and platforms that are preferential to those that a direct investor may have access to.

Client behaviour 

RYK VAN NIEKERK: What is your hit ratio? If you see ten clients and you spend a lot of time and effort designing retirement or investment plans for them how many of those clients do you typically sign?

STEPHEN KATZENELLENBOGEN: I don’t have the exact statistics but I would think probably eight in ten is probably a fair number.

RYK VAN NIEKERK: How many clients have approached different financial advisors and then compared the plans that are pitched to them?

STEPHEN KATZENELLENBOGEN: Recently more so than before. So we do get quite a few that come across and say I am seeing X and Y and just give me a week or two and once I’ve had a chance to look at all the portfolios I’ll get back to you. I think that’s a good thing. It’s good for clients to be able to see what’s out there from an advice perspective, from a cost perspective and the offering of the advisory business itself. I think another good thing is the internet. …as individuals we can go onto the internet and research what’s out there to get a good understanding. From our perspective we much prefer it when a client comes into a meeting prepared and educated.

RYK VAN NIEKERK: I think it’s the most critical investment decision you can make when you pick your financial advisor. Just lastly, what do you recommend a client look at before choosing a financial advisor?

STEPHEN KATZENELLENBOGEN: They need to look at the business itself: that there is the necessary compliance involved in that business, the necessary skill, the necessary systems and continuity is also an important thing. So you can do some simple things: you can look at the FSB registration numbers, you can look at the individual’s qualifications and experience, you could also ask for some referrals…. You need to see that their offering meets your needs and the scope of the offering and that there’s continuity there for you.

RYK VAN NIEKERK: Thank you, Stephen. That was Stephen Katzenellenbogen: he’s an executive director at the NFB Financial Services Group.

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ADVISOR PROFILE

Stephen Katzenellenbogen

NFB Private Wealth Management

AUTHOR PROFILE

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