It's Getting Harder for the Super-Rich

How the super-rich make money - at - the best of the international media

Most wealthy people would agree that making money is easier than preserving it after you've made it.

One reason is that making money is usually a full-time occupation, whereas preserving it is something you usually trust to others, or at best it's something to which you devote a few hours of your time now and again.

Another reason is that in your own business you develop the narrow range of highly-focused, specialist skills needed to find profits and manage risks, whereas managing your personal investment portfolio requires a broad range and quantity of detailed knowledge, both fundamental and current, beyond the capacity of an individual to acquire and maintain.

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The increasing complexity of investment products available intensifies the problem. In America, for example, it's reckoned there are now almost as many hedge funds as there are mutual funds - with the former much more diverse in their strategies and tactics, as well as being much harder to analyze, than the latter.

This complexity brings with it a need for more specialist advisers. Yet investors' experiences with these in recent years has undermined their credibility. Nearly all advisers said stick with equities when they should have said buy gold... or bonds; they put clients into supposedly safe companies such as Equitable Life or Enron rather than supposedly risky ones like tobacco firms.

Even among the wealthy, who are in a better position to find and buy good advice, there is a 'steady erosion' of trust in management service providers, Capgemini/Merrill Lynch say in the latest edition of their annual World Wealth Report.

This is leading 'Hinwis' -- high net worth individuals, defined as those with at least $1 million to invest, apart from the value of their homes and pension funds - to take a more active role in managing their personal wealth. And to demand better service from their advisers, such as more transparent reporting and index-based performance measures.

It's 'growing more difficult' for wealthy families to maintain their affluent lifestyles. The devastation wrought by the equity bear market forced many to change their spending habits. Inflation adds to the problem, especially for the super-rich. The prices of the goods and services they consume, such as private jets, Rolls Royces and luxury yachts, have been rising four times as fast as those used by the masses.

Here's how the Hinwis are currently managing their portfolios:

* They're pursuing higher-risk wealth-building strategies, but in combination with more emphasis on risk management and optimizing cashflow.

* They're pouring capital into 'alternative investments,' an asset class that encompasses derivative-based structured products, hedge funds, private equity funds, precious metals, commodities, foreign currencies and 'investments of passion' (fine art and collectables).

* The most favoured of these are the private equity funds, where investment in the US alone is approaching $200 billion. Last year the benchmark index of such funds gave a return of 23 per cent, compared to the 11 per cent of the S&P500 index of listed equities. A recent survey of America's richest families showed that half of them plan to invest more in private equity funds.

* They're increasing their global diversification, attracted by returns far higher in emerging markets than in developed ones. American Hinwis have increased overseas holdings to 30 per cent of their financial assets, with an important shift into offshore tax havens.

* They're cutting back on the amount of new money they're putting into hedge funds (where returns have plunged) and real estate (where high prices have raised risks and reduced prospects of future gains).

* But overall, they cleave to conservative, balanced asset allocations. Across the world as a whole, wealthy individuals have 34 per cent of their portfolios in equities, 27 per cent in bonds and bank deposits, 14 per cent in alternative investments, 13 per cent in real estate (other than their homes) and 12 per cent in cash.

The Capgemini/ML study estimates that there are now 8.3 million Hinwis in the world and they control $31 trillion, or about a quarter of global financial wealth.

Their numbers have been growing fastest in Asia and in countries with commodity and real estate booms. Last year the Hinwi population of Singapore grew by 22 per cent, to 49,000; of South Africa, also by 22 per cent, to 37,000; of Hong Kong by 19 per cent to 67,000; of Australia by 15 per cent to 134,000; and of India by 15 per cent to 70,000. In the US the Hinwi population grew 10 per cent to 2.5 million, and in Britain by 9 per cent to 418,000.

However, 2004 was exceptional because of a combination of the best world economic growth in two decades, cheap money and improving confidence.

This year, 'as world economic growth slows, wealth creation is likely to follow suit,' says the Capgemini/ML study. 'And with geopolitical turmoil, record trade deficits, low savings rates and high debt levels shaping financial markets, Hinwis will have to navigate carefully to maintain and enhance their wealth.'

The best way to navigate is to maintain direct personal control over the management of your wealth.

By Martin Spring in On Target, a private newsletter on global strategy