Fending off the crisis

While some wealth management groups and fund houses are battening down the hatches, tinkering with the odd product and hoping the financial crisis goes away, others are asking serious questions: how should we react to this current state of events? How should we change the way we do business with private clients? How can we actually profit from the circumstances we are faced with?

Rather than concentrating on products, which most banks have done, and losing money for clients, it is important for providers to move to service driven models, with different propositions for platinum, gold, silver and bronze segments, says Amin Rajan, chief executive of Create-Research who works with large private banks on customer-facing propositions.

“What our research shows, is that despite the bad performance of the last two years, you still have a 70 per cent chance of retaining the client if you can provide good service,” volunteers Professor Rajan. “The benefits of this for fund managers and private banks are very clear.”

The key is to make sure clients get a better service as they are upgraded to the next level. “Lloyds TSB’s wealth management division was upgrading people from the retail bank to the private bank and they made you feel so good, that you had become a gold category client,” he says. “But you were not getting anything in return, and when clients realised this, they wanted to go back to branch banking.”

The sheer scale of losses in private banking, driven by the current crisis, means most institutions are ready to change this supply-driven business model. Banks are realising that unless they can attract a new generation of “buy and hold” investors, the industry has little future, claims the Professor. The generation which forfeited investments during the dotcom bubble has already been lost to private banking, he believes.

One of the problems is that products have too many “bells and whistles” of dubious benefit to either clients or product manufacturers. “Very few businesses can survive a 40 per cent trop in gross revenue – they will blow up. For a fund manager to survive, they will need robust, variable cost models, where costs rise and fall with income. Having a lot of products does not give you the resilience to cope with the feast and famine cycles we are experiencing.”

Following Create’s latest study, Professor Rajan is proposing a wholesale rationalisation of funds, freezing base pay and making bonuses a larger amount of remuneration packages.

Product development

This is not necessarily a model followed by the whole industry. Aberdeen Asset Management, which is poised to take over much of Credit Suisse’s funds division, sees an opportunity to build products to fill more niches rather than rationalise its range. “If we take Asia as an example, and we have a mainstream Asia Pacific fund, this allows us to develop into more specialist areas such as China, India and Asia small cap funds,” says Gary Marhsall, Aberdeen’s head of collective funds. He sees the merger as an opportunity to launch new funds over time, and speed up the existing process of product development.

“The more you can offer in an asset allocation process, the more chance clients want these funds in some part of the cycle,” states Mr Marshall, proposing a radically different business model to the one championed by Professor Rajan.

“Private banks tend to look for a range of different funds they can switch money between,” says Mr Marshall. “You can take the Schroders approach and rationalise, or you can take ours: we have the infrastructure, now we must try and put some more revenue through it.”

At Goldman Sachs Asset Management, the planned response is to expand distribution activity, rather than product ranges, with global distributors and the German market identified as the premier areas of focus. “We are already Europe’s number one sub-adviser. We would also like to be a top five player in mutual funds over the next five years,” says Nick Phillips, head of third party distribution for Emea at GSAM. He names JP Morgan, Schroders and BlackRock as his key protagonists in Europe. “Germany has more cross-border mutual fund assets than any other country in Europe,” he says, explaining the renewed Teutonic focus. “Our distributors are telling us that our competitors there are retrenching, and that coverage was not as good as it was, so this crisis presents a significant opportunity for us.”

The majority of distributors in Germany use a “guided architecture” approach, which makes it relatively easier for companies on a select panel to acquire assets, believes Mr Phillips, who has laid down a plan to cover not only the German banks’ head offices, but also to provide regional coverage at bank branch level. “This is out first significant step into more retail mutual funds distribution,” he adds.

Significant opportunities

A “remarkably consistent approach” is being taken by GSAM staff across Europe in terms of products currently being highlighted to distributors, with corporate bonds, high yield and other fixed income specialities finding favour. “But people are also taking a new look at US equity,” believes Mr Phillips. “The US market was the first into recession and could be the first to come out, so there are benefits to investing in the US market now.”

There are also “significant opportunities” in alternatives on the sub-advisory side. While GSAM has witnessed large flows going into tactical, passive investment such as exchange traded funds, with which it is increasingly competing, Mr Phillips believes the longer money will choose quantitative equities, in the shape of enhanced index funds, currently popular among Nordic banks.

Overall, the crisis has led to a definite trend to keep products simple. “The customers of our clients need trust rebuilt in the asset management business, given what has happened over the last year,” says Mr Phillips. “We are talking about very simple products. Multi-strategy funds are definitely out of favour, as they are harder for clients to understand.”

In the past, GSAM has been able to sell hybrid high-yield and investment grade bond funds, but this has changed. “Today we need to separate the products out and explain how they will affect the portfolios,” says Mr Phillips. “A blurred or hybrid product is more difficult to explain.”

At the private banking arm of the Edinburgh-based life insurer, Standard Life, the view is that the crisis provides a huge opportunity for those wealth managers who can respond correctly. “The current crisis drives innovation. Some of the big, established players will end up losers,” claims David Tiller, strategy director at Standard Life Wealth, which currently runs £350m (E395m) after being launched one year ago.

“The shake out will highlight those companies that can innovate and produce the right sort of results. It will put pressure on some of the more traditional firms without the deepest of pockets.”

According to Mr Tiller, static asset allocations are not the way forward and clients “want a portfolio which will actually do something” over a three-year timescale.

Standard Life Wealth intends to use a broader investment universe to construct private client portfolios, with particular use of alternative investments and derivatives. He admits that much of the product line is “unashamedly borrowed” from the multi-asset funds deployed by much larger sister company, Standard Life Investments, Mr Tiller’s former employer, which specialises in liability-driven strategies. “We can create a unique vehicle for private clients, by using derivatives and cash and putting them into a unit trust,” says Mr Tiller, referring to the group’s Strategic Investment Allocation Overlay. “This has to sit aside other investments of physical assets and allows us to actively manage market risks on a much more dynamic basis, without adjusting the physical portfolio.”

This device is used particularly to bet on the outperformance of one market index against another, but in a safer, more flexible method than utilised by structured products or portfolio insurance, believes Mr Tiller. The key difference in a new approach must be to adopt the common-sense of first determining the goal of the client and then working towards it, he adds. “What do you want to achieve and how much is it going to cost? That is what you ask the client and then you work backwards from there,” he says. “Liability-driven investing will become more and more common for private clients.”

But Professor Rajan at Create is suspicious of too much reliance on institutional-style instruments and believes private bankers should plough their own furrow.

“Institutional quality funds were designed for a world which existed in the 1960s and 1970s,” he says. “I am very mistrustful of those tools. Models assume that the past will prevail in the future, but we are in an age of uncertainty. Insights are now far more important than a battery of tools. Insight is the most rare commodity in investment, and that’s what private bankers should be concentrating on.”

Zeno Staub, CEO of Vontobel Asset Management and former CFO of the group’s private bank, believes there are huge differences between the two approaches, but that institutional investment experts and private bankers need to work together to respond to the crisis. “One of the underlying drivers is that, unconsciously, the private banks are realising that it is hard to keep up and raise pure investment skills when you are a pure private bank,” comments Mr Staub, whose asset management division makes investment recommendations for the group’s private bankers. “The exchange of ideas and peer pressure you need to build investment skills is at the centre of an asset management operation. Pure private banks probably feel they need more skilled investment talent in-house, but it is hard to keep them with only private banking.

“Most private banks have one, two or three product lines or skills, which they can build into an investment fund and sell it to third parties. The first round of decision making is more margins, profits and scaleability.” But private banks run the risk of being one-trick ponies, if they take this approach, believes Mr Staub, and global investment skills, in the form of a fully fledged asset management operation is needed for true expertise to be maintained in house.

Declining wealth

Like Professor Rajan, Paul Burik, an independent consultant formerly employed by Commerzbank, where he reshaped a huge, global funds arm into a much leaner, domestically focused operation, believes providers must totally re-examine their business models in order to survive. There will be much less revenue to go round due to the serious decline in wealth, believes Mr Burik, leading to considerable pressure in the industry for more efficient processes.

“Consolidation will weed out players whose products are less differentiated and those with weaker distribution,” says Mr Burik. But like Standard Life Wealth, he also sees the need for liability-driven strategies. “High net worth businesses will increasingly be separating out client portfolios into that part used to accumulate assets for retirement, and another part for expenses for health and other needs in their working lives.”

These two pools will be run in a very different way to a much less serious third pool, earmarked for fun, entertainment and gambling on investment themes. “Investment firms can continue to distribute products in the same way for that portion of portfolios. Clients might think: ‘Bric countries or African equities, it’s a fashionable theme, I want to learn about it and go to cocktail parties where they discuss these things.’”

But the big shift will be investor mentality changing from how much they can make to how much they can lose. “That shift in attitude is not likely to disappear quickly,” says Mr Burik. “It may stay with a whole generation of investors. That is not how the industry has operated in the last 25 years. It is used to investors being focused on making a return and not spending too much time worried about the downside.”