Adjusting business models for the sub-optimal segment

Segmentation and profitability are supposed to be healthy bedfellows. However, in wealth management the ideal segmentation continues to frustrate many institutions. This is partly because ensuring profitability requires segmentation across more than one variable. In our view, the most simplistic segmentation that works involves three variables – asset levels, client geography, and sources of client wealth. Typically, however, many firms continue to promote segmentation purely on asset levels. This is fine, for a start.

In that context, we believe that for the full service private banking being promoted to clients around the world, the minimum asset level must be $10m (€7.7m). The deca-millionaire has purchasing power and investment habits that are better suited to the bespoke private banking solution. Moreover, the cost base to support such solutions can only be supported if accounts are at least at this level of investment.

Dis-economy of scale

The European houses are still coming to terms with this step change in their model offer. Many suggest their minimums are at the deca-millionaire level although in reality they are willing to accept assets well below this amount. To some extent, this suggests that the banks have not yet been forced to face the harsh reality of the dis-economy of scale of providing smaller accounts with more expensive solutions. The ‘loss leader’ theory only works if properly managed. But if 80 per cent of clients are sub-optimal in terms of account size there is real pain for the private banking business model.

In the US, the next stage of upgrading the model is beginning to take a more fundamental step. Human resources are being deployed specifically in the sector. For instance, Merrill Lynch is planning a 66 per cent increase in the number of advisers targeting clients with $10m, boosting the existing team from 240 to 400 advisers. The expansion will also see the number of HNW teams grow to 150 from 90 currently across the US. Merrill has announced that the bulk of growth will take place before the year end.

Meanwhile, UBS has detailed plans for its new Private Wealth Management Group (PWMG), formally launched in the US in May, targeting the same segment. PWMG will have 50 offices across the US by mid-2005.

Merrill Lynch identifies clients with $10m as its core HNW client base, following the strategy review that began in 2001. Key products for this group include assistance in concentrated stock positions and preferential loans. Merrill has indicated that 60 per cent of the new positions will be filled internally, but this will mean that around 60 positions will be filled through external recruitment.

In this context, UBS has calculated that there are around 100,000 US deca-millionaires who control $2.8bn or one-third of US HNW wealth. The UBS service offering will include concentrated stock solutions, wealth transfer strategies, philanthropy, lending and liability management, trust and estate planning. Of note, PWMG is headed by a five-strong management team, of whom four were previously with Merrill.

The Merrill and UBS announcements are evidence of the increasing clarity surrounding segmentation among US wealth managers. A recent article in the Wall Street Journal (WSJ) illustrates not only that segmentation is increasingly well defined, but that the thresholds are considerably higher than European counterparts. The median average of the firms in the WSJ report suggests the typical segmentation strategy is as shown in the table above.

Gap in services

Interestingly, the shift up the wealth ladder by the top US wealth managers suggests there may be a gap for tailored services targeting the $1–5m segment which we classify as the volume ‘private banking sector’. This client group has historically been the core client group for many of the top players and the most highly competitive market segment. However, with re-segmentation increasingly targeting pooled and plain vanilla offerings at this group, legacy clients may now be unlocked for new players.

Once again, the bedfellows may be struggling to get comfortable.

Sebastian Dovey is managing partner at wealth management strategy think-tank Scorpio Partnership