WEALTH MANAGEMENT-THE FUNDAMENTAL CHALLENGE Dominic Cooper, Bluerock Consulting THE FUNDAMENTAL CHALLENGE Following the boom years of the late 1990s, equity markets around the world are still well off their highs (see Figure 1 overleaf). The result of this is that percentage-based management fees have fallen because asset values are down, and transaction fees have fallen too because there is less market activity. The pincer movement is completed by pressure on the cost side. Cost bases were built up in the good times as banks rushed to invest, chasing a share of the attractive revenue streams associated with rapidly rising global wealth. Then the bubble burst in 2001 and although cost reduction programmes were started, many of which are continuing still, the lag effect leaves a profitability gap. So the fundamental challenge facing wealth management organisations is how to provide compelling products and services to ever more demanding clients, whilst at the same time controlling or cutting costs. And that's not all; it needs to be done against a backdrop of an increasingly complex regulatory environment including Basel II, the EU Savings Tax directive and changing local compliance obligations. It's also worth mentioning the need to make wise choices about technology as this is a significant cost area and decisions here are often seriously complex. ANSWERING THE CHALLENGE A number of business strategies are consistently being adopted across the wealth management industry to meet Dominic Cooper, a director of Bluerock Consulting, looks at some of the strategies being employed by wealth management institutions in order to boost profitability in the current cautious market. the fundamental challenge. Perhaps the most prevalent are consolidation, open architecture and outsourcing. Consolidation is a strategy that has been evident all around the world. Examples of the implementation of this strategy have been seen in Switzerland, including the mergers of Lombard Odier with Darier Hentsch and Union Bank with Discount Trust. Also, Deutsche Bank has recently acquired Rued Blass and Societe Generale now has a major stake in CBG Banking Corporation. However, this strategy is not unique to Switzerland as can be seen by the recent acquisitions of wealth management firms by UK banks. The purchase of Gerrard by Barclays Bank in a deal valued at £210m created the UK's largest private client investment business with £21.4 billion of assets under management, as well as trebling the number of individuals Barclays manages money for (this deal added around 116,000 accounts to its existing 45,000-strong portfolio). The acquisition of Bank of Bermuda by HSBC in a deal valued at £770m also bolsters HSBC's private banking business, adding a further 5,000 clients and £12.8bn of funds under management. UBS has also recently been in the news for acquiring on-shore businesses in France (from Lloyds TSB) and Germany (from Merrill Lynch), both for undisclosed sums. The term 'open architecture' is being increasingly used in wealth management circles. It refers to the capability of a wealth manager to take products and services from multiple / external suppliers and add them to the product mix offered to its clients. This enables clients to gain access to "best of breed" financial products without the wealth manager having to go to the time and expense of building up such products in-house. Each wealth manager determines its own product mix depending upon the product strategy that it wishes to deploy. In terms of observed market practice, the specialist Swiss private banks have, in general, tended to restrict their customers more to their own in-house products than the larger global players have (although due to their scale these latter organisations are often able to provide in-house alternatives to external products). Local providers in other markets have tended to take their lead from the Swiss. Another key trend is the outsourcing of non-core functions such as IT, settlement, cutody, trading and even research. The goal here is to enable the wealth manager to focus on core activities such as asset allocation and client servicing without being distracted by secondary factors. Whilst this may lead to an immediate cost reduction, the underlying objective is to swap fixed costs on the wealth manager's balance sheet for variable costs that may be matched more closely to the prevailing market conditions. KYC IS THE FINAL PIECE OF THE JIGSAW In addition to the organisational business strategies mentioned above, much of the wealth management industry is (re)implementing the behavioural strategy of focusing upon the client. Whilst endeavouring to cut costs and provide "best of breed" products, wealth managers are careful not to neglect the needs of their customers. Client focus has been a buzzword in the industry for several years now, but in the current depressed market retention of existing customers is seen as vital. The Know Your Customer (KYC) concept reinforces the client focus further. Originally an antimoney laundering initiative, KYC has become a driving force in enabling wealth managers to get closer to clients needs. Recent surveys have indicated that customers are raising the bar for what they believe constitutes a "must have", and that wealth managers can only ignore this trend at their peril. Research shows that a key factor in being able to retain clients is a clear and legitimate understanding of what high net worth individuals (HNWIs) expect, desire and need from a wealth management service. This understanding then needs to be translated into targeted and holistic financial services that are personalised so as to be relevant and appropriate. All of this should be delivered through qualified, well trained and (crucially) fully enabled client advisors - in short, clients want the perfect customer experience. Unfortunately, this same research has found that reality quite often falls short of expectations, and clients who are dissatisfied with their wealth management relationships are now less likely to stay loyal to their existing provider because the inertia that has kept customers with their existing providers is gradually breaking down. It is a truism that it is less costly to retain a customer than to gain a new one; the realities of customer acquisition costs and the benefits of leveraging revenue from current clients are just as relevant to wealth management as they are to mass-market retail finance. Concentration on sustaining and nurturing the client relationship is therefore imperative, particularly in an environment where customers have seen the value of their investments fall over the last three years whilst at the same time high fees have continued to be paid to their wealth managers. The result is that wealth management organisations are placing increasing emphasis upon the training of client advisors in all aspects of their role, to develop them as effective and client focused relationship managers. A second widespread goal is the achievement of first class client servicing, through the creation of systems platforms that enable the efficient, seamless delivery of products, services and information from client advisors to clients. THE BOTTOM LINE The late 1990's was a time of rapid expansion in the wealth management industry as banks and other institutions sought to take advantage of rising equity markets and the consequent increase in HNWI wealth. However, times have been much tougher since the turn of the millennium; the subsequent bear market across much of the globe has caused havoc and led to changes in the underlying structure and economics of the industry, with established business models coming under significant profitability pressure. Changing industry dynamics have lead to significant revenue falls at a time when underlying cost bases have not fallen at the same rate. This is particularly the case in North America and Europe where wealth management providers have had to look at ways to reduce their costs, often through techniques such as outsourcing and consolidation, as well as via the more traditional method of headcount reduction. Whilst improved sentiment in the global equity markets is likely to remove some of the pressure on margins, it is expected that outsourcing and consolidation are trends that will, if anything, increase over the coming years as wealth management providers seek to regain the high levels of profitability seen previously. However, these profits must be earned from clients whose preferences have changed and who have become far more discerning following their experiences of the recent bear market. These customers now expect, as hygiene factors, not only access to products that are appropriate to their individual situation, but also first class customer service. The wealth managers who will succeed and prosper over the coming years are those that successfully control their underlying cost structures whilst at the same time ensuring that the overall client experience improves. This is likely to be quite a challenge for wealth management providers, but those who survive and succeed in this delicate balancing act will be well positioned to take full advantage of the next cyclical economic upturn. WEALTH MANAGEMENT - A GLOBAL PERSPECTIVE Bob Heath, Bluerock Consulting Bob Heath of Bluerock Consulting outlines the key factors affecting for the wealth management industry around the world. North America saw a period of contraction in the wealth management industry during 2002 as investors lost approximately 10% of their wealth over the course of the year. This degree of contraction was significant, but actually less than that experienced in 2001. On the upside, improvements in the equity markets following the second Gulf War of Q2 2003 are widely expected to help reverse this situation from 2004 onwards. This contraction in the market saw a fall in assets under management (AUM) of 30% in the period 1999 to 2002. This trend, coupled with a consequent shift in investor sentiments to less risky investments, helped to put a strain on existing business models. As a consequence, North American wealth management providers with feebased business models responded by cutting costs, largely through reductions in headcount. Fee-based providers have also needed to review their cost bases, although they have been more reluctant to cut headcount. Europe has seen a similar situation to that experienced in North America, namely shrinking AUM as a result of falling equity indices. The resulting reductions in revenue, and relative increases in costs, have also meant a greater focus on both cost reduction activities and mergers aimed at creating economies of scale in the back office, the latter being a particular trend in Switzerland. These cost pressures have also been compounded in Europe by increasing regulatory pressure, particularly with regard to tax regimes. This pressure has manifested itself in three forms: tax amnesties; capital repatriation programmes; and intergovernmental withholding tax agreements. This changing landscape poses significant challenges to the European wealth management industry. This is particularly the case for those Swiss and other institutions that are heavily reliant upon the offshore market. Whilst tax regime changes have meant a repatriation of assets from offshore to onshore accounts, the rate at which this repatriation has taken place has been lower than initially expected, proving that offshore accounts hold attractions above and beyond simple tax efficiency. Swiss wealth management institutions have also been successful in retaining AUM through offering their clients onshore alternatives, often through the acquisition or creation of onshore branch offices. The Asia-Pacific region has seen a growing demand for wealth management products. The more mature markets in the region have seen their economies remain relatively flat over the last few years, leading to a more benign environment than that experienced in North America or Europe. At the same time, emerging economies have continued to grow at a steady rate during this period. The overall effect of this has been to produce an increasing pool of wealth in Asia-Pacific at a time when that of North America and Europe has been declining. However, whilst this has meant that local wealth management operations in Asia-Pacific have continued to be profitable, the relatively small size of the market has not yet led to large-scale inward investment from the global players. China and India are both believed to represent significant opportunities for wealth managers. There is substantial high net worth individual (HNWI) wealth - and core affluent and ultra HNWI assets too - and growth rates are projected to outperform the global market. The downside is that asset gathering can be difficult, especially in China where international banking facilities like FX and brokerage are less prevalent, and because most of all the pool of wealth is Yuan denominated and difficult to move off-shore. India has recently made it easier for international banks to operate within its borders and players like Citibank, HSBC and Standard Chartered may be looking to increase their presence. The South American wealth management industry has also seen a period of consolidation. Although HNWI wealth has grown moderately in recent years there is evidence that onshore foreign banks are retrenching, or indeed withdrawing, because of the generally depressed state of the major Latin-American economies. This situation has not been helped by increasing political instability and a flight to offshore providers, particularly those from the US and Europe, that can offer more stable investment backgrounds. Where global providers have entered South American markets they are experiencing strong competition from local and Spanish banks, particularly for the remaining onshore wealth management business. These organisations often possess distinct advantages over their global competitors, arising from strong cultural affinities with potential clients, together with existing relationships derived from local retail branch networks.