Framework for Strategic Asset Allocation for Private Individuals using Behavioural Finance & Gap Analysis and

Strategy Formulation: Competition Landscaping in Private Banking Space

Project Report on Summer Internship at ICICI Bank

Submitted to: Prof. M. Venkateshwarloo

Submitted by: Arpit Tiwari Roll No. 20 PGDIM-15

Certificate

This is to certify that Arpit Tiwari, Roll No. 20, PGDIM-15 has completed a 2-month Summer Internship at ICICI Bank from April 13th 2009 to June 12th 2009.

This report is submitted towards the fulfilment of the requirements of the 4th Module of the PGDIM course of NITIE, Mumbai.

PROF. M.VENKATESHWARLOO

Acknowledgement

I would like to take this opportunity to thank everyone associated with me on this endeavour. I thank the Director of NITIE Mumbai, Dr. Shubhas Awale, for giving us the opportunity to work in prestigious organizations around the country. I thank Prof M.Venkateshwarloo for his constant support and guidance, fa iling which this effort would have amounted to nothing. I thank the entire Financial Solutions Group at ICICI Bank for all their help. I especially thank my Guide, Mr. Rupesh Satnaliwala and my Mentor, Ms. Radhika Jain as this whole project was under her supervision. Finally, I thank my parents, relatives and friends for their never ending support and good wishes.

Table of Contents
EXECUTIVE SUMMARY ................................ ................................ ................................ ............... 4 COMPANY BACKGROUND ................................ ................................ ................................ .......... 5 OBJECTIVES OF THE PROJECT ................................ ................................ ................................ ..... 6 Project Title ................................ ................................ ................................ ............................ 6 Project Brief ................................ ................................ ................................ ............................ 6 Project Description ................................ ................................ ................................ ................. 6 Traditional way of Asset allocation................................ ......... Error! Bookmark not defined. Global Private banking industry................................ ................................ ........................... 8 METHODOLOGY ................................ ................................ ................................ ......................... 9 MODELLING AND ANALYSIS ................................ ................................ ................................ ..... 11 Analysis of current strategic asset allocation model at ICICI Bank ................................ .......... 11 Pros and Cons of current asset allocation model................................ ................................ ... 12 Models studied and analysed................................ ................................ ............................ 13 Details of wealth allocation framework ................................ ................................ ................ 15 Risk Allocation ................................ ................................ ................................ .................. 20 Asset Allocation ................................ ................................ ................................ ................ 22 Likelihood of achieving goals: Scenario Analysis ................................ ................................ 23 Key recommendations ................................ ................................ ................................ .......... 30 FUTURE SCOPE ................................ ................................ ................................ ......................... 31 LIMITATIONS ................................ ................................ ................................ ............................ 32 ACADEMIC CONTRIBUTION ................................ ................................ ................................ ...... 33 BIBLIOGRAPHY/REFERENCES ................................ ................. ERROR! BOOKMARK NOT DEFINED. ANNEXURES ................................ ................................ ................................ ............................. 35

Executive Summary
The project work can be divided into two parts. These are: a> Developing framework for Strategic Asset Allocation for Private Individuals using Behavioral Finance b> Competition Landscaping in Private Banking space The focus of first part was to first analyze the existing model of Strategic Asset Allocation for Private Individuals used by Financial Solutions Group (FSG) of International Banking Group of ICICI Bank. An in-depth analysis of current model revealed pros and cons of the current model. A need for a model which captures individual s risk elements in an effective and efficient manner was felt. Inclusion of behavioral finance in traditional framework was required to effect the same. Four models were studied and analyzed in detail. These models were evaluated for criteria which are desired in a good model. These criteria were incorporation of client s risk elements, ease of explanation, flexibility, ease of implementation, cost efficiency etc. Finally a wealth allocation model was chosen and recommended for implementation. Some additions and modifications were done to this model to suit ICICI Bank needs. This model follows a compartmentalization approach to Asset Allocation and creates three buckets catering to different needs of an individual. A step by step procedure was developed to implement this model in ICICI Bank. The second part of the project was a competition analysis with respect to positioning/branding strategy, approach to advisory services, advisory considerations and products and services provided to private clients. Here top ten banks which provide private banking services were compared. The products and services were classified into different categories for analysis. The focus was to suggest strategy, products and services etc. which would help ICICI Bank become a strong player in Private Banking. This also involved talking to Relationship Managers of ICICI Bank in DIFC (Dubai International Financial Centre) region. Based on these talks and above comparison suggestions were made for strategy, products and services.

Company Background
ICICI Bank (formerly Industrial Credit and Investment Corporation of India) is India's largest private sector bank by market capitalization and second largest overall in terms of assets. Bank has total assets of about USD 77 billion (at the end of December 2008). The Bank also has a network of 1,449 branches and about 4,721 ATMs in India and presence in 18 countries, as well as some 24 million customers (at the end of July 2007). ICICI Bank offers a wide range of banking products and financial services to corporate and retail customers through a variety of delivery channels and specialised subsidiaries and affiliates in the areas of investment banking, life and non-life insurance, venture capital and asset management. ICICI Bank is also the largest issuer of credit cards in India. ICICI Bank has got its equity shares listed on the stock exchanges at Kolkata and Vadodara, Mumbai and the National Stock Exchange of India Limited, and ADRs on the New York Stock Exchange (NYSE). The Bank is expanding in overseas markets and has the largest international balance sheet among Indian banks. ICICI Bank now has wholly-owned subsidiaries, branches and representatives offices in 18 countries, including an offshore unit in Mumbai. This includes wholly owned subsidiaries in Canada, Russia and the UK (the subsidiary through which the hisave savings brand is operated), offshore banking units in Bahrain and Singapore, an advisory branch in Dubai, branches in Belgium, Hong Kong and Sri Lanka, and representative offices in Bangladesh, China, Malaysia, Indonesia, South Africa, Thailand, the United Arab Emirates and USA. Overseas, the Bank is targeting the NRI (Non-Resident Indian) population in particular. International Business Group The primary task of the IBG is to develop and implement the global components of ICICI Bank s Universal Banking strategy. IBG has the following business teams:
y y y

Country Teams NRI Services International - Financial Institutions Group

Objectives of the project

Project Title a> Framework for Strategic Asset Allocation for Private Individuals using Behavioural Finance b> Gap Analysis and Strategy Formulation : Competition Landscaping in Private Banking Space Project Brief a> Framework for Strategic Asset Allocation for Private Individuals using Behavioural Finance
y y

To develop a comprehensive strategic asset allocation model for private individuals To incorporate individual s risk factors in the model

b> Gap Analysis and Strategy Formulation : Competition Landscaping in Private Banking Space
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To suggest strategies, products and services required to make ICICI Bank a major player in Private Banking space

To identify positioning/branding strategy of top private banks

Project Description a> Framework for Strategic Asset Allocation for Private Individuals using Behavioural Finance Traditional Way of Asset Allocation: In traditional way Asset Allocation is done by using Markowitz Modern Portfolio Theory (MPT). In MPT framework an efficient frontier is calculated based on risk return characteristics of each of the portfolios. Each point on the efficient frontier represents a portfolio for which return is maximum for a given value of risk or alternatively risk is minimum for a given level of return. Once this frontier is obtained the point on the frontier where an individual s utility function is tangential to efficient frontier is the point of optimum asset allocation for that individual. (Refer Exhibit 1 below)

Exhibit 1 6

Need for a behavioural finance based model: There are two main drawbacks of traditional MPT. These are:
y

Traditional MPT does not take into consideration perception of risk of individual, it talks about and incorporates risk at aggregate level i.e. at market level and ignores individual risk.

The utility function as described earlier is measured at some future or terminal point in the time horizon. In other words, the individual is assumed not to be sensitive to how the portfolio reaches that terminal state, but focused only on that terminal point. This is a sensible assumption in the world of institutional investing. It is however a less obvious fit in the world of the individual investor. Individuals are more sensitive to changes in states than to absolute constructs. Thus, an individual whose portfolio, though substantially up in value from a year ago, is down from a recent peak will probably be less happy than another whose portfolio has risen less, but in a smoother manner. This focus on change rather than absolute levels must tell us that individuals will tend to be path dependent:

Behavioural finance addresses both the issues discussed aboveand hence the need to develop a model based on behavioural finance. b> Gap Analysis and Strategy Formulation : Competition Landscaping in Private Banking Space Private Banking at ICICI Bank: Private Banking at ICICI Bank is channelized through their GPC (Global Private Clients) channel. The business model used to be a sales driven model whereby ICICI Bank used to sell (it still continues to use this model in some location) its own as well as third party products to its clients irrespective of the fact that whether those products are suitable for them or not. This model though simple to implement suffers from one major drawback i.e. it does not consider suitability of a product to client s needs and preferences. A client can get a highly risky product irrespective of the fact that he has regular income needs and he is risk averse. To eliminate this drawback ICICI Bank changed its sales driven model to advisory based model in 2007 with launch of advisory services in DIFC region. It plans to launch this service in Singapore also. Advisory is facilitated by FSG (Financial Services Group) of International Banking Group. There are Solutions Managers in FSG group who develop strategic portfolio for a client. Generally 5-6 RMs (Relationship Managers) are mapped to each Solution Manager. Solutions

Managers are also responsible for giving tactical calls to their client s when favourable market conditions are prevalent. Global Private Banking Industry: Globally private banking is there for decades. Major Private Players include UBS, Citibank, HSBC etc. There has been a tremendous increase in number of wealthy individuals globally. This fact has opened a lot of new opportunities in this field. ICICI Bank has first mover advantage as it is the Indian Bank with largest international presence. Over the years its international business has grown by leaps and bounds. In spite of this success story ICICI Bank still is a very small player in this big area of private banking. It has yet to make its brand visible in people of non Indian origin. To tackle this challenge it needs to develop effective strategies and innovative products and services. Since private banking business is based wholly on Trust it should learn from the leaders in the industry. The motivation of this study was to learn about the strategies of top private banks and what are they doing, so that ICICI Bank can see where it stands now and where it want to go in future and what path it can take to reach that point.

Methodology
a> Developing framework for Strategic Asset Allocation for Private Individuals using Behavioral Finance The methodology used for this part of the project was to evaluate different models of strategic asset allocation; these are the models which incorporate an individual s risk preferences. Each of these models was evaluated based on few parameters. These parameters are:
y y y

It should incorporate clients risk elements in consideration apart from market risks It should be easy to explain to clients if need arises It should be flexible so as to allow modifications as a result of change in clients preferences, situations, and changes in lifestyle etc.

y y y

It should be sustainable It should be easy to implement It should be cost efficient

At the same time there are various constraints which involve tradeoff and a good subjective judgment. These constraints are:
y

It should be decided whether model should be subjective/intuitive or it shall be rigorous quantitative in nature.

Also a decision must be taken regarding tradeoff between ease of calculation vs. accuracy.

Finding these models involved searching Wealth Management Journals, Internet, Wealth Management Magazines and other sources. b> Gap Analysis and Strategy Formulation : Competition Landscaping in Private Banking Space The methodology followed for this part was to check all the information related to private banking provided by top ten banks providing private banking services. List of top ten banks providing private banking services was taken from www.euromoney.com. Once this list was found, information provided on the website of each of the banks was analysed. There were few aspects which were evaluated. These aspects are:
y y y y

Positioning/Selling/Branding Advisory approach Advisory Considerations Products : Products were further subdivided into following products

Banking 9

Investing Financing Research

y Services : Services were further subdivided into

Financial Advisory Exclusive Services Online Services

Comparison based on these parameters was captured in a excel sheet for each of thes e banks. In addition to above comparison an analysis of ICICI Bank s existing positioning strategy, products and services, positioning of advisory, areas of strength and weaknesses was made. The procedure here was first to prepare a questionnaire covering all the aspects discussed above. Then each of these questions was asked to RMs (Relationship Managers) and SRMs (Senior Relationship Managers). The rationale of asking these questions to RMs and SRMs was that these are the people who actually represent ICICI Bank in front of clients so their views on these issues provide very valuable insight into these aspects. Responses of each of the RM and SRM was tabulated in excel format. Based on this and the comparison of banks providing private banking recommendations were made regarding strategy, products and services.

10

Modelling and Analysis

a> Developing framework for Strategic Asset Allocation for Private Individuals using Behavioral Finance Analysis of current strategic asset allocation model at ICICI Bank: In existing asset allocation model the first step is to gather all the information about a client using FFFQ document also known as Financial Fact Finding Questionnaire. FFFQ: This document has three subsections. These sections are:
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General Information: It consists of questions and details about family, current asset allocation among three asset class which are debt, equity and alternatives, personal assets and liabilities, income requirement, investment experience etc.

Investment attitude questionnaire (IAQ): This contained various objective type questions to judge investment attitude of a client. Each question had four options and each choice had different points attached to it. Based on the response of a client his total score is calculated. There are five ranges of score and depending on the score of a client and the range in which his scores fall determined a client s subjective risk profile. There were five types of profiles. These were in order of increasing risk tolerance
y Risk Averse y Conservative y Balanced y Growth y Aggressive

y Investment preferences: It asks client for information on their preferred asset

allocation, their liquidity needs, time horizon, investment goals, estate planning needs and any other information which might be helpful in determining their strategic asset allocation plan. Based on the subjective risk profile of an individual his assets are allocated to debt, equity and alternatives based on already decided weights to each of these asset classes. For example for a risk averse client a typical allocation would be 80% debt, 20% equity and 0% alternatives. Also within each asset class the weights depend on market conditions and client requirements. Currently in ICICI Bank there is no advisory on debt instruments, allocation within this asset class depends on client s and RM s discretion. FSG only tells what portion of client s total 11

asset will be in debt. For equity, they provide advisory in equity based Mutual fund. Currently there are eight types of mutual funds which ICICI Bank offers to their clients. Asset allocation to these mutual funds depends on liquidity, income and growth needs of clients. For alternative investments allocation depends on market condition and good judgement. From time to time, based on market situations tactical calls are given to clients and these calls do affect the strategic asset allocation but in the long run it tend to stick to strategic asset allocation. Pros and Cons of current asset allocation model: Current model is good in the sense that it is easy to understand and implement. Also it takes client s goals into consideration. It is more important for a client to meet his goals rather than just earning a good return on his investments. Additionally risk profiling of the current system takes into account both elements of individual risk i.e. ability to take risk which is an objective measure as well as his desire to take risk which is a subjective measure. On the other hand this model is highly subjective; there is no reasonable way to ensure that client s goals will be met. While it takes into account the objective measure of client s risk i.e. his ability to take risk it does not translate this into any scale or any quantitative measure. Also since there is no optimization used, asset allocation may be sub optimal. These all deficiencies in current model requires introduction of new model to strategic asset allocation. Approaches to strategic asset allocation problem: In current literature there are two approaches by which various wealth managers, practitioners and pioneers in this field have tried to solve strategic asset allocation problem.
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Bucketing or Compartmentalization approach: This approach divides all assets, liabilities, goals etc. into various sections and each section is used to fulfil a particular need of a client. In essence it creates various sub portfolios out of all the assets and each sub portfolio meets some distinct need of an individual. Risk is defined according to type and criticality of goal.

Total portfolio or traditional approach: This approach tries to solve strategic asset allocation problem by using a single portfolio approach. All goals and objectives are tried to be met with a single portfolio. Traditional MPT approach is this approach only.

12

Models studied and analysed: Four models were studied for selecting one model for ICICI Bank asset allocation model. Details of all the models are given below:
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Goals based investing: Goals based investing is an essentially a bucketing / compartmentalization approach model. Here different strategies are made for each of the goals investors might have. Each goal will have a different risk measure. For example for a goal of income generation the risk would be defined as the probability of not getting required income in a particular month and suitable strategy for this goal would be to invest in annuity generating instruments. Similarly there can be goals of liquidity, capital preservation, growth etc. and there would be suitable strategies for these as well.

Exhibit 2 depict the philosophy of goal based investing Goals-based investing improves upon traditional approaches in the areas of measuring risk, risk profiling, and managing behavioural biases.
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Wealth Allocation Framework: This is also one of the bucketing / compartmentalization based approach. It creates three buckets based on the components of risk covering individual s conflicting behaviour of being greedy and having fear for loss at the same time. The buckets and their rationale of creation are: 1> Personal Risk: This protects an individual from personal risk. This means protecting oneself from anxiety regarding a dramatic decrease in one s lifestyle. 2> Market Risk: One need to take on market risk in order to grow one s wealth segment and maintain one s lifestyle. 3> Aspirational Risk: One could take on aspirational risk if one desire to break away from one s wealth segment and enhance your lifestyle.

13

All assets, liabilities, goals etc. are divided among each of these buckets and then allocations are made based on risk profile of a client in each of these buckets. Likelihood of meeting a client s goals is estimated and an iterative process is followed till the time success is achieved.
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Holistic Optimization of goals: This model is based on total portfolio approach. It approaches problem of strategic asset allocation as a simultaneous solution of asset location and goal planning. It also incorporates impact of taxes in model construction. First step is to divide the asset locations into taxable and tax exempt. The logic behind is that some assets which are subject to high taxes must be placed in tax exempt locations which makes them give better after tax returns. Similarly tax efficient financial instruments can be put into taxable locations. Once this is complete projection of future cash flow associated with each goal is done. Inflation also needs to be incorporated in this estimation. After this present value of each set of goals is calculated and in order to prioritize these goals target value of probability required achieving these goals is set. After this using some standard solver optimization is done. A series of optimization is done for each of the goals and some constraints. For example for first goal optimization gives the combination of assets that would create an expected portfolio return with the largest risk adjusted spread to the required expected return for meeting first goal. A probability value of meeting that goal is also estimated. Second optimization would be optimizing asset mix with a constraint that probability value of first goal shall not go below a desired probability value. This process is carried out for all subsequent goals. At the end of this process one has an optimum portfolio which meets all of these goals with desired probabilities.

Discretionary Wealth Framework: This approach is also one of the complete portfolio approaches as described earlier. In this model all assets including those related to human capital and the present value of personal spending requirement, including those for retirement, lifestyle and wealth transfer are put into a implied balancesheet. Discretionary wealth is what remains after subtracting the present value of personal spending requirements from assets. As the non-discretionary present value of personal spending requirements liability becomes a smaller and smaller proportion of total assets, the discretionary assets becomes asymptotic with the total portfolio. This ratio determines the how conservatively the asset portfolio

14

should be managed. If this ratio is large there is greater need to manage the portfolio conservatively and if the value becomes small aggressive approach to portfolio management can be taken. In this model all the assets are treated as one portfolio. After evaluating each of the models on the parameters described in methodology section Wealth allocation Framework was found to be most suitable for ICICI Bank needs and it was suitably modified to make it more implementable as per the requirements of ICICI Bank.

Details of Wealth allocation framework To develop a comprehensive wealth strategy the definition of portfolio was expanded to cover all assets and liabilities such as investments, home, mortgage, and human capital. Human capital can be loosely defined as earning potential. A person s portfolio should allow him to achieve the following three purposes: Protection from anxiety/poverty: This is referred to as protection from personal risk. Ability to maintain his standard of living and status in society, i.e., keep up with family and friends. In order to do this, investors must earn a rate higher than inflation and thus take on market risk. Provide an opportunity to increase his wealth substantially or meet his aspirational goals. This involves taking on some aspirational risk. So an ideal portfolio must provide: 1. The certainty of protection from anxiety. 2. The high probability of maintaining one s standing. 3. The possibility of substantially moving upwards in the wealth spectrum.

In this framework risk allocation precedes asset allocation. Exhibit 3 illustrates each risk dimension with its corresponding objective and trade-offs. In summary: Allocations to the personal risk bucket will limit loss of wealth, but will yield below-market returns. Allocations to the market risk bucket will provide risk-adjusted market returns (this is the Markowitz framework). Allocations to the aspirational risk bucket should yield higher-than-market returns, but with the risk of substantial loss of capital

15

Exhibit 3 Investors should have very different performance expectations for the assets allocated to each of the three risk buckets, and these expectations must be benchmarked against appropriate indices (Exhibit 4). The idea of having a different benchmark for each of the three parts of the portfolio is an important one. In the first bucket one pays for and receives safety. In the third bucket one gets outsized returns, unfortunately accompanied by a significant probability of loss of capital. These two parts of the portfolio, in general, will behave differently than the middle portion, which can be benchmarked against risk-adjusted market indices. In fact, often the entire portfolio will be mean-variance inefficient, when viewed in the narrower mean-variance framework, but will provide more robust protection and upside, when viewed over a wider range of outcomes. Assets in the personal risk bucket should be expected to appreciate at below-market rates. Suitable benchmarks are the Consumer Price Index or three-month LIBOR. Suitable risk measures could use downside risk rather than volatility. Assets in the market risk bucket follow the standard Markowitz framework. Their performance can be compared to a standard benchmark constructed fromappropriate weighting of the S&P 500 and an aggregate bond index. Similarly, the Sharpe ratio can be used to provide a suitable risk-adjusted measurement. Assets in the aspirational risk bucket should significantly outperform standard market indices when they succeed. Examples of such benchmarks could be Forbes magazine s Cost of Living Extremely Well Index (CLEWI) (Yen [2001]), a hedge fund index, or a large alpha

16

over a standard market index. Other risk measures could incorporate default probabilities or use upside risk rather than volatility.
Personal Risk Market Risk Do Not Jeopardize Basic Maintain Lifestyle Standard Of Living Protective Assets Market Assets Below market returns for Market returns and market below market risks risks S&P 500 Consumer Price Index Lehman Agg. Bond Index 3-month LIBOR MSCI World Index Downside Risk Standard Deviation Scenario Analysis Sharpe Ratio Sortino Ratio Beta Roy Ratio Scenario Analysis Aspirational Risk Enhance Lifestyle As irationa Assets Above-market returns with high targeted risks CLEW Index Absolute Return Value Upside Return Measures Manager Alpha Scenario Analysis

Expecte Performance a mple Benc marks

Risk Meas res

Low Risk/Return

Risk/Return Spectrum

High Risk/Return

Exhibit 4 Classification of Assets To classify an asset both the type of asset and the purpose it serves in the portfolio determine the placement of each asset into one of the three different risk buckets. Therefore, the same asset can belong in different buckets for different individuals. Assets that provide some degree of stability or principal protection clearly fall in the personal risk bucket. Examples are cash, short-term government-backed Treasury bonds, TIPS (i.e., bonds that provide inflation protection in exchange for a lower yield), principal-protected mutual funds, annuities of certain kinds, and option hedges such as puts and collars. Other assets that we now include in this bucket are: Primary residence, offset by the liability of a mortgage; Insurance on automobile, home, catastrophe, disability, life, offset by the premiums; Human capital, i.e., earning power, offset by educational debts. Most conventional securities fall into the market risk bucket, as long as they are part of a diversified portfolio. Alternative investments like funds of hedge funds, commodities, etc., can belong here as part of a diversification strategy, as long as transaction costs, liquidity constraints, and manager risks are mitigated. Executive stock options, concentrated stock positions, single-manager hedge funds, leveraged investment real estate, and call options are examples of investments that fall in the aspirational risk bucket. A family-owned business that forms a significant part of an individual s wealth would also belong here. For more examples see Exhibit 5

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Personal Risk Market Risk Do Not Jeopardize Basic Maintain Lifestyle Standard Of Living Protective Assets Market Assets - Cash - Home Purchase - Equities - Home Mortgage - Broad size and Style - Safe Investments and Sector Exposure - US TSY(Short Duration) - Fixed income - TIPS - Credit Quality and - Principal Protected Duration diversification Funds - Cash (reserved for - Annuities to provide safe opportunistic investing) source of income and - Strategic investments hedge longevity risk - Funds of funds - Hedging through - Liquid non traditional calls/puts/collars investments e.g. - Insurance commodities - Human Capital

Aspirational Risk Enhance Lifestyle Aspirational Assets

- Alternative Investments - Private Equity - Hedge Funds - Investment Real Estate - Investment Concentration - Small Business - Concentrated Stock and stock option positions

Low Risk/Return

Risk/Return Spectrum

High Risk/Return

Exhibit 5 Implementation Steps: Exhibit 6 gives a step by step procedure to implement this model in developing a strategic asset allocation model for private individuals. These steps are: 1. Gather complete diagnostic information: Understand lifecycle details Determine client goals and priorities Assign cash flows and timelines to each goal Classify current assets and liabilities Include current and future cash flows Risk questionnaire to determine client risk factors and personal danger zone 2. Perform risk allocation and asset allocation, portfolio construction: Categorize and evaluate current state Make intuitive adjustments 3. Compute likelihood of achieving goals using: Scenario analysis 4. Readjust: Risk allocation Client goals & cash flows 18

Asset allocation within each risk bucket 5. Repeat Steps 2 to 4 till success and optimum balance are achieved. 6. Check robustness of solution to market and client risk factors. Market risk factors: crash Client risk factors: inflation 7. Implement. 8. Review and readjust as needed. Each of these steps needs to be analysed and developed in more detail to make it implementable in ICICI Bank s context

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Risk Allocation: As explained earlier there are two aspects of an individual s risk. These are financial ability to take risk which is an objective measure and desire to avoid risk which is a subjective measure. To determine financial ability to take risk we need to understand lifecycle details, current net worth including non investment assets. Also we need to determine client s goals and priorities. The next task would be to scale the objective risk measure so that one can quantify objective risk measures. The approach is similar to one described in discretionary wealth framework. This can be done as described below:
y

Estimate present value of total worth of an individual including his total human capital i.e. his total earning potential. This can be done by using his current income and expected increase in income over the years. The knowledge of his number of years in work i.e. the difference between his retirement age and his current age is also required. By assuming a constant growth rate in income and assuming a suitable discount rate this estimate can be completed by using equation below:

Here

is present value of human capital, is expected growth rate in income, is current

income, is suitable discount factor, is difference between his expected retirement age and his present age. Present value of total worth can be calculated using formula given below:
 

is present value of total worth.

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Second step is to estimate present value of total liabilities. This requires factoring each and every expenditure which a person is expected to incur in his life time i.e. this goes beyond retirement as well. The expenditure needs to figure both i.e. general day to day expenditure as well as expenditure which are made rarely and cost a lot. Addition of family members also needs to be considered. Since inflation erodes value of money and increases price levels as well it also has to be incorporated in this. This requires a lot of estimation and detailing.

Once this step is completed one can calculate present value of total net worth by subtracting present value of total liabilities from total worth of a person.

y y

Repeat this process for a large number of old and current clients. Calculate average and standard deviation of this data. 20

Assuming a normal distribution plot this data and then calculate ranges of values of total net worth required for intervals of 10% probability distribution from probability distribution function. For example calculate value of total worth required for ranges 0%-10%, 10%-20%, etc. till 90%-100%.

Develop a scale where an individual can be assigned a certain value depending on his present value of total net worth.

Update this data by repeating the whole process once a year since there will be changes in income levels, growth rate, inflation rate and other parameters involved in above calculations.

ICICI Bank s FFFQ document already quantifies the subjective risk aspect i.e. desire to take risk. Factors which are critical in evaluating this aspect is minimum wealth level which is personal danger level and target return rate of individual. Once one has values of both these aspects of individual risk one can plot this on risk allocation graph to determine risk profile of an individual. (Refer Exhibit 7)

Subjective Risk Measures

Desire to Avoid Risk

Balanced Growth

Aggressive

Risk Averse Conservative

Balanced Growth

No allocation to aspirational bucket Objective Risk Measures Ability to take Risk

Exhibit 7 After finding the risk profile of a client check from the risk allocation chart (See Exhibit 8), what shall be the desired risk allocation for that type of client? This allocation is derived from past data and thumb rules. It is result of good judgement and there is no quantitative base for this allocation.

21

Risk Averse Conservative Balanced Growth Aggressive

Risk Allocation Rang s Personal Market Aspirational 60.00% 40.00% 0.00% 50.00% 45.00% 5.00% 45.00% 50.00% 5.00% 35.00% 55.00% 0.00% 30.00% 55.00% 5.00%

Exhibit 8 Asset allocation: Divide all assets and liabilities (includes future liabilities as well) into each of the three risk buckets as per the definition of the buckets as described earlier and find the net worth of each bucket. Find the percentage worth of each bucket as compared to total worth. (See Exhibit 9)

Personal isk Do Not Jeopardize Basic Standard Of Living (x%) Protective Asset Asset 2 Liability Liability 2 Net ets

Market isk Aspirational isk Maintain Lifestyle (y%) Enhance Lifestyle (z%) M rket ssets Asset 2 Asset 22 Liability 2 Liability 22 Net Aspirational Assets Asset 3 Asset 32 Liability 3 Liability 32 Net

Exhibit 9 Ask intuitive questions on current asset allocation. These questions could be:
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Does the client have correct risk allocation among different buckets given his various goals, needs, wants, risk profile etc.?

Does the client have the right asset allocation within each bucket?

22

For each of the bucket check following things: Personal bucket: Check liquidity, risks due to rising interest rate, check cash flows etc. Market risk: Check whether it is fully diversified or not. Aspirational bucket: Check if allocation to this bucket is not disproportionately very high.

Make adjustments: Based on the responses from above questions and ideal asset allocation based on a client s risk profile make suitable adjustments. For example make suitable adjustments i.e. spread risks, sell some assets and buy some, convert mortgages from floating to fixed or vice versa based on future prediction. After doing readjustment again find the net worth in each of the bucket and calculate percentage net worth with respect to total net worth. (See Exhibit 10)
Personal Risk Do Not Jeopardize Basi Standard Of Living ( ' ) Prot tiv Asset 11' Asset 12' Liability 11' Liability 12' New Net Market Risk Maintain Lifest le (y' ) M rket et Asset 21' Asset 22' Liability 21' Liability 22' New Net

Aspirational Risk Enhan e Lifestyle (z' ) pirational Asset 31' Asset 32' Liability 31' Liability 32' New Net et

Exhibit 10 Likelihood of achieving goals: Scenario Analysis Scenario analysis is a simple tool to check portfolio performance in different market scenarios. Exhibit 11 presents a simple table to evaluate portfolio performance in six different scenarios. For each scenario one has different return values for each of the buckets. Multiplying the total net worth of the bucket with this return figure will give us net worth of that bucket in a particular scenario. Also summing the net worth in each of the bucket we can get total net worth of all the buckets combined together. This analysis can be done for both current as well as recommended asset allocation. Once the correct allocations have been made in the three buckets, the middle bucket should be diversified as prescribed by MPT.

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23

Description Short Term Underperform nce Long Term Underperform nce ikely I ikely II Optimistic ong Shot

Person l M rket Aspir tion l Portfolio (%) Portfolio (%) Portfolio (%)

et Worth ($)

et Return (%)

et Worth ($)

4 4 4 4 4

0 7 7 0 0

-50 - 0 0 50 00

Exhibit 11 The return figures in each of the buckets for different scenarios can be estimated using global outlook of economy, research reports, Advisory Council (Advisory Council is a committee comprising global experts, economists etc. who provide regular insights into world s economy, views on different markets, views covers different asset classes and different geographic markets. Once the return for each type of asset is estimated, the return for a particular bucket is just the weighted sum of returns on all the assets forming that bucket. Exhibit 12 shows how Scenario Analysis can be used to check likelihood of goal completion. In this particular exhibit net worth of a portfolio is plotted for each of the scenarios listed above and comparison of the performances between current and recommended allocation.

Comparison of Performance Under Different Scenarios

6500000 6250000 6000000 5750000 5500000 5250000 5000000 4750000 4500000 4250000 4000000 3750000 3500000 3250000 3000000 2750000 2500000 2250000 2000000

Exhibit 12

9 8

4 5 6

9 9

- 0

- 00

C B

et Return (%)

B B

A A

@ 9 8

24

Probability of achieving goals: Using z values of normal distribution There is one more method to calculate probability of achieving goals. This is done by using statistical method. The assumption involved here is that portfolio returns follows a normal distribution curve and return and standard deviation figures are known. Steps involved are:
y Calculate the present value of cash flows required to meet the goal y Convert this to required return from portfolio in terms of percentage returns y Calculate average return and standard deviation of the portfolio using historical values y Calculate z values using following formula:

Here is required rate of return, is historical rate of return, deviation and is the number of years data taken into account.
y Calculate probability using probability distribution function

is historical standard

Iteration: If probability of achieving goals is less that desired then readjust:

y Risk Allocation y Client goals and cash flows y Asset allocation within each bucket

Repeat this process until the optimum balance and desired probability of success is achieved. Also incorporate market shocks in Scenario Analysis e.g. market bust like Credit Crunch etc. Advantages of suggested Wealth Allocation Model:
y y y y y y y

Highly intuitive Easy to understand and explain Easy to implement Sustainable Flexible Cost Efficient Integrate all aspects of client's risk factors

b> Gap Analysis and Strategy Formulation : Competition Landscaping in Private Banking Space Analysis of information obtained from the website of top banks providing private banking services:

25

Branding
y UBS : It position itself as a bank with high client focus and high degree of

customisation
y Citigroup : They mention about their proprietary asset allocation methodology called

Whole Net Worth methodology of investment and also they boast about their global presence
y HSBC : It has an international network, people and range of products and services y Merrill Lynch: It boasts about its ultra high net worth clientele. Approximately one

fourth of Forbes Top 500 CEOs are Merrill Lynch clients

y Deutsche Bank : It sells itself on global presence and excellent quality of Relationship

Managers
y JP Morgan : It brands itself as provider of exceptional depth and breadth of services y BNP Paribas : It has excellent pool of human and technical capital y Societe Generale : They have an innovative open architecture approach y ABN Amro : It positions itself on its clientele base and strength of group

Advisory Approach:
y Understand, Propose, Agree and Implement, and Review approach coupled with life

cycle approach (Various stages in a person's life and associated needs) : UBS
y Manage, Develop and Preserve approach and work with independent financial

advisors and other financial institutions : HSBC

y Focus on holistic health plans : Citigroup y Four areas of wealth planning i.e Family, Business, Finances and Real Estate and

lifecycle approach : SG
y Employment of global resources and expertise for investment advisory : ABN Amro y Screening, Fundamental Research, Portfolio Construction and Implementation

approach, focus on relationship building, provides detailed brochure for each service : Credit Suisse
y Exclusive Access, Custom Services, Expert Advisors approach : Merrill Lynch y Advisors' compensation based on clients' performance : JP Morgan y Case studies on website to demonstrate the advisory approach y Wealth management magazine

Advisory Considerations:
y Lifestage of a person

26

y Return Objectives y Current financial situation y Reference Currency y In addition to Risk attitude, Investment horizon, Cash flow needs, personal priorities,

liquidity etc Products (Banking):

y y y y y y y y y

Variety of bank accounts Variety of Deposits Cards and Travelers' cheque Payment Services Overdraft and bridge over facilities Sweep accounts Personal Credit Lines Treasury and Foreign Exchange Corporate banking

Products (Financing):
y Loans (Secured as well as Unsecured) of various tenor y Mortgages y Letters of credit y Credit facilities for foreign exchange, precious metals etc. y Speciality financing y Residential and commercial real estate financing

Products (Investing):
y y y y y y y y y y

Equities Fixed Income Structured Products (Notes and Warrants) Mutual Funds Private Equity Hedge Funds Foreign Exchange and Commodities Liquidity Management Separately and discretionary managed accounts (Large number of mandates Insurance 27

Real Estate and Exchange Funds

Products (Research):
y y y y

Financial Research and Analysis Funds Research Capital Markets trends research Manager search and selection research

Services (Financial Advisory):

y y y y y y y y y y y y

Pension provision Retirement Tax Advisory Structuring business assets International transactions and relocation services Fund restructuring and administration Trading Active Advisory Portfolio Management Concentrated Stock Management Risk Management Business Valuation

Exclusive Services:
y y y y y y y y y y y y

Family office services Philanthropic planning Gift and Estate Planning Corporate Wealth Management Speciality Asset advisory Custodian Services Gold and Numismatics Corporate Employee Financial Services Aircraft Advisory Sports Advisory Home Advisory and Concierge Services Islamic banking

Business Services/Services targeted to specific professionals

y

Executives 28

y y y y y

Business owners Independent financial advisor Various financial intermediaries Law firms and attorneys Media and Sports person

Online Services
y y y

Online monitoring of portfolio Customized research reports Relationship reports

Analysis of responses of the questions asked with RMs and SRMs: Positioning of ICICI Bank
y

NRI / Clients of Indian origin :

 They already know about bank  India based offerings  Global Presence  Financial results

y y y y

Non NRI clients History Singapore based accounts First Indian bank to be listed on NYSE

y Key differentiators: India based products primarily deposits, venture capital and PE

funds
y

Alternate bank in the ranks of 3-5 (AUM wise)

Positioning of advisory
y y y y

Tell them about customisation FSG team and experts in the team Benefits of advisory Portfolio Management services provided by FSG in terms of regular updates and outlook is well appreciated by clients

Products in demand but not offered currently

y y y y

Global products US based products Gold exchange products Structures 29

y y

Very few varieties of bonds Local currency products

Weak Areas
y y y y y

Lack of online platform Booking over telephone Services Products Poor in communication

Key recommendations based on analysis of both i.e. comparison of top ten banks in private banking space and responses of RMs and SRMs
y y y

Advisory approach shall be put on website of ICICI Bank in detail. Case studies elucidating advisory approach shall be mentioned on website. Company can work with law agencies as well as client s independent financial advisors in order to earn confidence of a client.

y y y y y y

Islamic Banking can be offered in DIFC region by having strategic tie ups with local players Breadth as well as depth of products needs to be increased Relationship Managers should educate client about importance of advisory services Online services shall be developed for clients. Booking over telephone shall be introduced. Communication to clients shall be made in a effective manner

30

Future Scope
a> Developing framework for Strategic Asset Allocation for Private Individuals using Behavioral Finance
y y y

Effect of taxes on the asset allocation model should be studied Evaluation for suitability of various measures of risk should be done Optimization of assets in personal risk and Aspirational risk bucket shall be studied in more detail

Performance parameters of alternative investments needs to be studied in more detail so as to calculate probability accurately

b> Gap Analysis and Strategy Formulation : Competition Landscaping in Private Banking Space
y

Positioning strategy of different banks should be studied from perspective of clients as well as relationship managers

y y

Client s perception of ICICI Bank shall be analysed by talking to clients Feasibility of introducing Islamic banking by ICICI Bank in DIFC shall be studied

31

Limitations
a> Developing framework for Strategic Asset Allocation for Private Individuals using Behavioral Finance
y y

Creating buckets in asset allocation introduces sub optimality in asset optimization Risk weight allocation does not have a quantitative base and is based on good judgment

Wealth allocation model gives underperformance in normal markets which can lead to less terminal wealth if normal market conditions exists for a long period of time

b> Gap Analysis and Strategy Formulation : Competition Landscaping in Private Banking Space
y

Whole analysis was based on the data available on website of various banks which makes it dependent on the accuracy of data

This analysis does not consider legal issues involved in introducing new products or services in many countries so many products suggested for introduction may actually not be introduced due to legal issues

Responses of RMs may suffer from some cognitive and other biases which compromises accuracy of analysis

32

Academic Contribution
y y y

Knowledge of Organizational Behaviour applied to Financial Behaviour Knowledge of business statistics Knowledge of financial management (time value of money concept, present value, future value etc.)

Extensive support from journals and white papers

33

Bibliography/ eferences
1. Brunel, Jean. Revisiting the Asset Allocation Challenge Through a Behavioral Finance Lens. The Journal of Wealth Management, Vol. 6, No. 2 (2003), pp. 10-20. 2. Chhabra, A., and L. Zaharoff. Setting an Asset Allocation Strategy by Balancing Personal and Market Risks. The Journal of Wealth Management, Winter 2001, pp. 30-33. 3. Chhabra, Ashvin B. Beyond Markowitz: A Comprehensive Wealth Allocation Framework for Individual Investors. The Journal of Wealth Management, Spring 2005, pp. 8 34. 4. Wilcox, J. Harry Markowitz and the Discretionary Wealth Hypothesis. Journal of Portfolio Management, Vol. 29, No. 3,(2003), pp. 58 65. 5. Fowler, G.B., and V. de Vassal. Holistic Asset Allocation for Private Individuals. The Journal of Wealth Management, Vol. 9, No. 1 (2006), pp. 18 30.Vuyk, C. (2003). 6. Nevins, Daniel. Goals-Based Investing: Integrating Traditional and Behavioral Finance. The Journal of Wealth Management, Spring 2004, pp. 8 23. 7. Brunel, J. How Sub-optimal - If At All - is Goal-Based Asset Allocation? The Journal of Wealth Management, 8 (Fall 2006). 8. UBS website, information about strategy, advisory, products and services extracted from http://financialservicesinc.ubs.com/wealth/Home.html 9. Citibank website, information about strategy, advisory, products and services extracted from https://www.privatebank.citibank.com/our_services/individuals_families.htm 10. HSBC website, information about strategy, advisory, products and services extracted from http://www.hsbcprivatebank.com/services/index.html 11. Merrill Lynch website, information about strategy, advisory, products and services extracted from http://www.pbig.ml.com/publish/mkt/pbig/index.html

34

Annexures
Annexure I: Questions for RM New Clients

1. How do you get a lead/contact on the new client? Is there some standard way across ICICI bank or standard way developed by you? 2. How do you position ICICI bank in front of a new client? Strengths of ICICI bank Types of services Range of products Differentiators Attractive features of a product or service which sets it apart from similar products provided by other banks 3. How do you position advisory services of ICICI bank? Do you do it separately or is it a part of overall bank positioning? Again for advisory services how do you pitch? 4. Why should a HNI choose ICICI bank's services over other banks providing similar services or products? 5. Have you found out any specific service/s or product/s which are in demand and currently not offered by ICICI bank? What effect it had in terms of client relationship? 6. Has there been an instance where a client drifted away from the bank after showing reasonable amount of interest? If yes what were possible reasons? 7. What do you think is the first impression of the client about ICICI bank? 8. What do you think are the areas where ICICI bank is not that strong? Existing Clients 1. Is there any measure to evaluate the quality of service provided? a. Response time b. Average client complaints per month c. Efficiency and effectiveness of the solution provided 2. Are there any follow ups about the satisfaction levels? 3. Is there any demand by existing clients to offer a particular type of service/products? 4. What do you think is the impression about the ICICI bank in existing clients' mind? 5. Has there been a instance where a existing customer drifted away from ICICI bank? If yes what could be possible reasons according to you? 35