The traditional expat life – whereby a senior executive could spend 20 or 30 years enjoying a pampered lifestyle with his or her company picking up the tab for extras like private school fees and housing – has become increasingly rare, as countries such as Singapore prioritise domestic workers. As part of the change, shorter assignments are becoming the norm, which creates tax planning complexities.
All this, Dugan believes, has necessitated a shift in thinking on the part of their wealth managers.
Fundamentally, the new expat model creates an unpredictability in financial planning that financial advisers increasingly have to manage, he says.
“Expats don’t go in with a lifetime plan," Dugan explains. "They need to keep an open mind as to where they will end up. For us, we have to determine their cash requirements, whether there will be a significant move from one currency to another, whether they need tax advice.
“It is often an uncomfortable fact-find because we are essentially trying to say that while we recognise that it all feels certain now, we also need to plan for uncertainty. This means keeping an element of flexibility in the way we build portfolios and arrange wealth.”
Striking a balance
Dugan joined Coutts in July 2012, having been in the business for 30 years. His first job was with the National Coal Board Pension fund in 1982, but over the years he has been an expat himself, in Dubai and Singapore.
During his time in the wealth industry, he has seen the priority shift to "solutions-based" advice, looking at the liabilities people are trying to meet. To do this, financial planners must build an idea of where people are likely to be in the future, and of the risks to their ambitions, he says.
“The wealth industry in general has realised that it is not just about giving people advice, but trying to draw out what kind of liabilities they are trying to meet in the future," Dugan explains.
“We are not just trying to draw out what they want to do today, but how those plans might evolve or change over time.”
In practice, this means creating balance in a portfolio, particularly on currencies. Hard currencies are likely to form the core of a portfolio because they are less volatile, but Coutts recommends keeping a balance in domestic currencies for shorter-term needs.
Dugan says: “We try to create a balance of currencies, but we are still trying to anchor people back to their domicile of origin. People often go back to the UK irrespective of the sun-kissed island on which they may live currently. When they are 60 they will need a pot of money to fund retirement and healthcare needs. We would also look at where their main property is situated.”
However, there are reasons to hold domestic currencies in the shorter term. In this income-constrained environment, it can help to access the domestic bond markets in an expat’s country of work with many paying as much as 2-3% higher on their domestic bonds.
Emerging market bond markets have developed significantly over the past five years and a significant part of an expat’s lifestyle will be in that currency, at least in the short term, so the additional yield is useful, argues Dugan. At all times, he is trying to ensure that people do not have an asset/liability mismatch that they are not expecting.
Protecting assets
Philosophically, Dugan believes 90% of risk is around asset allocation and so this is where they focus the majority of their efforts: “Everyone gets very excited around stock selection,” he says, “but selecting, for example, equities over bonds at the right time in the market has been crucial – particularly during the credit crisis.
“We concentrate on building the right asset allocation and then would hope to add a bit from stock selection. The asset allocation is created to bring a 7-8% return in the relevant currency. The stock selection would add 1-2% on top. Most of the conversations with clients are focused on trying to get them in the right place in regard to their asset allocation. Of course, we then try and ensure that their allocation to, say, Asia, is managed by a strong manager who can add value.”
That said, Coutts does not throw the asset allocation around. The group does employ tactical asset allocation, but not enough to fundamentally change the characteristics of a portfolio.
Dugan says: “If we had a 40% allocation to equities, we might take it to 35% or 45%, but nothing more dramatic than that because we believe the allocation we set at the outset should serve them through the cycle.
“I’ve been always been an advocate of sensible amounts of tactical asset allocation, but not to the extent that you change the underlying characteristics of the portfolio. Different asset classes are volatile and it is better to get a moving average through those experiences.”
When deciding on asset allocation, Dugan aims to identify those factors that consistently offer insight into future performance. The group tries to be as quantitative as possible, but not everything can be modelled. Dugan gives the example of the current situation in Japan. He is concerned that Japan is not delivering on its structural change and there is the potential for the market to slide if the government does not follow through on its promises. This is a qualitative judgement and cannot be modelled, but this would be the exception.
Coutts still sees itself as providing bespoke portfolios. There are some model portfolios for clients at lower levels of wealth. Dugan says: “It is difficult to tailor for less wealthy clients because it is too expensive to get access to the investments. Investors need 20-30 holdings for adequate diversification. Coutt’s philosophy is to provide tailoring as far down as we can. With a complex case with someone abroad, it needs to be tailored.”
Challenging environment
Dugan remains sceptical about the strength of the global recovery. He believes that, in reality, the global economy is limping along, barely getting out of the crisis.
“The UK, for example, is going through a good period, but there is still too much debt in government. We all get excited because interest rates are low and it supports most assets, but if there is no growth, the equity market returns are going to be wholly dependent on dividend income. The picture for the bond market does not look good either. It is quite a challenging environment.”
This is particularly problematic for Coutts’ natural demographic. “Our clients tend to be 40 to 55,” Dugan says, “and therefore we would typically rely on bond exposure to provide stability. But bond markets are, depending on your view, either over-valued or fairly valued, but aren’t going to offer much return over the next 10 years. I spent 25 years feeling I had solid building blocks for portfolios, but that has changed. The characteristics of bonds have changed and equities are actually looking more bond-like. That is changing the way we invest. Over the next six to 12 months, we can probably convince ourselves these interest rates are going to generate a lot of global growth, and equity markets can still make progress, but situations like the political impasse in the US will nag away.
“The burden of debt is a big problem, whether that is politically, for the markets or for our lives and our future. Japan got away with it because it was the only one, but now all the G7 are in the same position.”
The hunt for growth
Dugan favours an equity income-heavy approach, but adds that has got more sophisticated over time. Initially it was to buy anything with a high yield as long as that dividend is growing. Now he is increasingly asking how that growth is generated. He is hunting out the significant global trends that can defy the prevailing lacklustre economic growth – the growth of the middle income group in China, for example.
He believes if he can find inherent growth that is a good place to be investing and if he can find income as well, so much the better. He has also become more nuanced in his bond exposure, using securities such as US loans to diversify away from the mainstream bond asset classes.
Portfolio construction for expats has become more complex, because the expat experience has changed and there are no longer the ‘solid building blocks’ from which to select investments. In this environment, Dugan believes in keeping an open mind, building portfolios that can adapt to clients’ changing needs and, above all, ensuring that portfolios are geared to long-term liabilities.
