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Emerald Group Publishing Limited
Copyright © 2008, Emerald Group Publishing Limited
Struggle for profit?
Article Type: Commentary From: The Journal of Risk Finance, Volume 9, Issue 4
How to build sustainable profits in high-end wealth management
As the wealth-management market has grown healthily over recent years, shareholder expectations have risen. Indeed, there are some compelling arguments to suggest that growth in this market can, and should, continue. However, we contend that there are also some powerful forces that may weigh on wealth managers in their struggle for profit.
European wealth managers have performed well over recent years. Total income among European market participants grew by an average of 14.1 and 5.8 percent in 2005 and 2006, respectively; and 2007 is looking like a bumper year. At the same time, financial institutions worldwide suffered a 17.1 percent drop in share prices in the year to March 2008. Given the market turmoil dragging on certain banking sub-sectors, investors may look to wealth management and private banking for some relief from the bad news stories currently weighing on the financial services market.
More attention needs to be paid by financial institutions to the high-end of wealth-management provision, serving those in the Ultra- and very-high net-worth individual (HNWI) segments (those with $15 million or more in investable assets). Accommodating these high-end groups is crucial if wealth managers are to maximize shareholder value. They represent over 50 percent of the financial assets held by all private clients. And in recent years, their wealth has been accumulating faster than the rest of the private client market. The high-end is significant for other reasons. This elite group is likely to be the most resilient to any downturn in asset-prices and is therefore important to sustained revenue and profitability. In addition, this more sophisticated private client group can act as a lens through which we can see the future of service provision. Demands made by these clients are often a pre-cursor of products and service demanded by the lower-end of the HNW client market. Getting propositions right for this client group will therefore pay dividends for a wider client base.
Shareholders are understandably optimistic for wealth managers to perform – they see potential for growth from several avenues:
It is possible to increase penetration into each client group. Studies of UK-specific wealth patterns suggest almost 50 percent of wealthy families do not consult professionals before investing. “Going it alone” is clearly considered an option and indicates that there is much below-the-line wealth to be captured by wealth managers.
Wealth managers’ can increase penetration among target clients by capturing more of clients’ assets/wealth. As a broad average, our interviews with private clients show that just 25-30 percent of their wealth is made available to the wealth-management market. Although much of the remaining 70-75 percent of wealth may be held in traditional illiquid assets (i.e. property, art, tied company stock), private clients’ assets are rarely static. Our discussions also showed that private clients managed 4.7 wealth-management relationships and displayed some latent demand to rationalize this number. Thus, there is scope to increase revenues-per-client by capturing greater wallet share.
There is also an opportunity to take more targeted approach to the customer base. For instance, the number of Ultra-HNWIs grew at 11.3 percent to 94,970 and their assets grew at 16.8 percent. More sophisticated segmentations based upon source of wealth, purchasing behavior, or even ethnicity can be used to target and capture high-growth or high-profit groups.
Given these potential avenues for growth, expectations for the sector are riding high. However, looking to the horizon, Europe’s wealth-management market is likely to be a tougher place in which to grow profitable revenues. A range of powerful forces are aligning that will, left unchecked, erode wealth manager’s growth and profitability.
First, any decline in asset prices is likely to drag down wealth managers’ margins. While wealth managers continue to drive revenues through an “ad valorem” scale (based on the value of AUM) they have failed to diversify their revenue streams with more advisory-based fees. This may leave margins exposed in a downturn.
Second, operational issues are likely to restrict their ability to grow new clients or their capacity to deliver a quality proposition. For instance, where a banking service is based on one-to-one relationship management, any growth in the client base remains restricted to the rate at which wealth managers can grow their front-line staff numbers. And any change to the client loadings (the ratio of relationships managers to private clients) may impair the ability to serve client demands. This dilemma is also pushing up staff costs. In 2006, average compensation costs rose at 11.5 percent, whereas average non-compensation costs reduced 0.3 percent.
Third, client profitability is not being maximized. This is due to two factors. First, costs are not decreasing fast enough. Cost to income ratios for the wealth-management sector have reduced from an average 75.4 percent in 2004 to 71.1 percent in 2006. This is still significantly higher than the average for universal banks across their functions (61.6 percent over the same period). Second, RMs are failing to progress their clients onto higher value, lower cost services. Across the client segments, wealth management and private banking is witnessing a rise in less profitable execution only mandates and a decrease in higher value advisory and discretionary mandates.
The decline in asset prices, operational limitations that restrict further growth and their ability to serve, escalating costs and suppressed client profitability all have the potential to drag down margins. Our extensive, in-depth discussions with private clients point to another powerful force. A significant portion of the client base is disconnected from, and lacks trust in wealth-management institutions. There is, in short, a trust deficit.
Private clients’ trust deficit manifests in three ways: relationship managers tend to be seen as “product pushers”; clients are often unsure if they are receiving objective advice or best-in class products; and many private clients do not rate the investment expertise of their wealth managers. This lack of trust negatively impacts wealth managers in two ways:
The trust deficit directly restricts profitability. High-end private clients often retain key decision making, exhibit “parts buying” behavior and typically appoint external advisors to “manage their wealth managers.” Or they simply avoid wealth-management market as far as possible.
The trust deficit represents a significant obstacle to growing high-value services. Wealth managers are seeking to broaden their revenue platform with more discretionary mandates and advisory fees by building businesses around the “trusted advisor” model. A widening trust deficit restricts wealth managers’ in growing such revenue streams.
Reconnect with clients
To reconnect with their high-end customer-base wealth managers should re-align their propositions so that they are driven by the factors most important to clients. From our discussions, we have distilled three principles upon which private clients typically base their decision making:
Diversification. Private clients place an average of just 25-30 percent of their wealth into the market, diversifying into a range of wealth-management products as a safeguard against losses elsewhere. Clients also diversify by placing business with several wealth-management institutions – using on average the services of 4.7 wealth managers at any one time.
Performance. Many high-end private clients priorities performance over the quality of service and banking relationships, expressing a need for more responsive wealth managers.
Efficiency. Private clients seek greater efficiency in basic processes. While banks continue to broaden their range of products and services, their clients are more concerned that the existing repertoire is executed more effectively.
Wealth managers should build client insights around these core principles. From this base, they should extrapolate client segmentations that enable banks to shape tailored propositions for each client group. This segmentation approach will facilitate delivery against private clients’ core needs. It will also improve wealth managers’ ability to progress each client up the value chain towards improved client profitability as offerings more closely reflect the requirements of each segment.
We illustrate several segmentations: finance professionals, entrepreneurs, property owners and inherited wealth. Wealth managers can build scaleable propositions for each segment at the same time giving each client a tailored service that more closely approximates their needs.
To reconnect with clients it is critical for wealth-management institutions to reposition their offerings, tying front and back offices more tightly together. We advocate the following steps:
Client insight analysis. To provide the client insights necessary to underpin successful transformation.
Segmentation strategy and client value management. To form the basis of scaleable, tailored propositions and improved client profitability.
Retool for efficiency and effectiveness. To bring simplified more robust basic processes and more effective services to multi-banked high-end clients.
Transform the service delivery/distribution model. To improve client perceptions of private banking expertise and improve teamwork to deliver more of the firm.
Build a more integrated capability. Across banking functions to bring a more joined up approach and accommodate clients with interests that often span different divisions.
Although many wealth managers are working towards some of these transformations, leading wealth-management institutions will take a coordinated and strategic approach to complete on all five.
Based on a forthcoming report on wealth management authored by Seb Cohen at Deloitte & Touche LLP.
Deloitte Research 2008. Based on a sample of 19 of Europe’s leading wealth-management and private banking firms. At the time of publication, many leading wealth managers were reporting FY07 double digit revenue growth.
Deloitte Research, 2008.
Deloitte Research, 2008.
Merrill Lynch/Cap Gemini, World Wealth Report, 2007.
Tulip Financial Research, 2007.
Our survey assessed the assets held of each private clients interviewee. Wealth not placed with wealth managers was also held in retail banks, building societies or in less liquids assets such as private firms, real estate and collectibles.
Based on a definition of Ultra-HNWI with $30 m in free investable assets. World Wealth Report, Merrill Lynch/Cap Gemini, 2007.
Assets under management.
Deloitte Research, 2008, based on a sample of 23 European service providers.
Regional variation in costs is extensive. UK average was 64.5 percent, Swiss 65.7 percent, Benelux 51 percent and Germany 72.6 percent in 2006. Swiss Banking Institute, 2007.
Deloitte Research, 2008, based on a sample of 23 European service providers.
Compeer analysis on the UK market, 2007.
Chris GentleDeloitte, London, UKcgentle@deloitte.co.uk