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Cap Gemini Ernst & Young and Merrill Lynch’s latest report on the world’s wealthy reveals that despite the difficult economic conditions in 2001, growth in high net worth individuals rose by approximately 3 per cent. Elizabeth Cripps reports. Market size and growth The rich got only a little richer in 2001. According to this year’s World Wealth Report from Cap Gemini Ernst & Young and Merrill Lynch, the wealth of high net worth individuals (HNWIs) – defined as those with more than $1m in financial assets – grew by just 3 per cent to $26,200bn. This growth, which barely beat inflation, was the slowest since the report was first published in 1997, but is expected to pick up again as the economy recovers. HNWI financial wealth is forecast to grow by an average of 8 per cent a year to reach $38,500bn in 2006. The number of HNWIs also grew by approximately 3 per cent to reach 7.1m in 2001, a rise of 200,000. The figures compare with 6 per cent growth in HNWI wealth for 2000, and 18 per cent for 1999, which was a year driven by expanding gross domestic product (GDP) and rising stock market capitalisation. GDP expansion, already falling off in 2000, continued to decline in 2001, and the combined capitalisation of world stock markets fell by more than 13 per cent. The terrorist attacks of September 11 gave a dangerous boost to volatility, with the CBOE VIX volatility index reaching close to 60 points. “The question we often get asked is, if stock markets have declined so much, why has wealth increased at all,” says Lars Weigl, global head of wealth management consulting services at Cap Gemini Ernst & Young. “The reason is not just that some people have invested in fixed income. There is also the whole element of newly created wealth. It’s not all about losing out on this share versus that share, because there are people out there creating new businesses even in times of hardship, and that is creating wealth for them.” HNWIs, moreover, held onto their assets rather more successfully than their less affluent counterparts. “Most people in the HNWI category tend to be relatively sophisticated investors,” the report says, “relying on actively managed portfolios to counterbalance losses in one area with gains in others.” Mr Weigl adds that the “food chain” of the investment market gives HNWIs an advantage through better access to information and advice. When something affects the market, he explains, the first investors to hear about it are institutions, then HNWIs. At the bottom of this “food chain” are the self-directed mass affluent investors, who are often the last to pick up on any news. Another glimmer of hope comes from the “stealth bull market” identified by some analysts even amid the dire overall figures. In other words, there were some markets where a significant number of stock values rose substantially, but were eclipsed by the spectacular losses of the so-called “new economy”. Although the S&P 500 dropped 11.9 per cent in 2001, over 40 per cent of its stocks rose in value. Regional outlook Western, Central and Eastern Europeans lost out most in 2001. Accounting for 32 per cent of global HNWI wealth, Europeans ended the year with only a 0.1 per cent improvement on 2000, to $8400bn (see Fig 2). North Americans managed a 1.7 per cent hike to $7600bn. “Europeans do still have a substantial proportion of their investments in equity,” says Christopher Humphry, vice-president, strategy & transformation, at Cap Gemini Ernst & Young, and project director for this year’s report. “And the reality is that the European stock markets did worse than the US stock markets.” Market capitalisation for Europe fell by 20.1 per cent in 2001, to $7500bn, compared with a fall of 8 per cent for North America. Latin American and Asian HNWIs, by contrast, saw their wealth go up by 8 per cent and 7.1 per cent, respectively. Latin Americans were buoyed by a tendency to stick to fixed income, particularly dollar-denominated bonds, while Asians not only saw their own markets do comparatively well, but had learned to diversify their portfolios in the wake of the Asian crisis. Changing tactics HNWIs began to shift their portfolio mix in 2000, according to the report. By 2001, faced with sustained market volatility, economic uncertainty and depressed equity markets, they continued on that tack, repositioning more of their wealth into fixed income, cash, deposit holdings, and other physical assets. Defensive interest rate cuts, pushing up property prices, sent many HNWIs into this “safe” option, while they rebalanced their other equity holdings from technology to blue-chips and from growth to value stocks. HNWIs’ appetite grew dramatically for alternative investments and structured products. Hedge fund assets increased by 34 per cent, with HNWIs taking the lion’s share. With Van Hedge’s Global Hedge Fund Index up 6.1 per cent and such structured products as principal protected notes providing a welcome opportunity to preserve capital, it is easy to see why. HNWIs, according to Mr Humphry, will move back into equities over time. But it will take a couple of “solid” quarters’ of corporate earnings to convince them, and so they are unlikely to start the shift back before the second quarter of next year. The Atlantic divide North America and Europe account for 67 per cent of HNWIs and 61 per cent of their wealth. The markets are similar in terms of both HNWI numbers and wealth, but very different historical legacies have left them with distinct attitudes to investment. The relative distribution across the wealth bands is fairly similar between the two continents, as are the personal profiles of HNWIs. There are some differences in terms of age and source of wealth, however. (See Figs 3, 4 and 5.) The American Dream The European rich – seeking to protect themselves from hyperinflation, high taxation and war – have long demanded confidentiality, discretion and stability. Hence the stereotyped, ultra-confidential image of the Swiss bank account. They also have a stronger inclination towards investing offshore. European HNWIs are believed to account for more than $2500bn of the $8500bn total HNWI wealth invested offshore. This is more than twice the estimate for North Americans, who have been shaped instead by a politically and economically stable history, and a large, coherent market – in short, benefiting from the so-called “American Dream”. The inevitable question is how much September 11 will shatter this image, and propel more US HNWIs towards offshore investing. But North Americans have not reacted to this sudden attack on their own soil, as Europeans have to a war-dotted history, by hiding their assets away offshore. “The US HNWI has traditionally always invested a much higher proportion of wealth domestically, partly due to their strong equity culture, and it will take much to change this,” says Mr Humphry, “and although they did alter their portfolio mix noticeably, there was no rush into investing offshore. Also, the speculation that the perpetrators may have been using offshore centres in some way to finance the events also made the US HNWI cautious and suspicious about investing offshore.” Europeans, moreover, are expected to move steadily away from this offshore emphasis. “The wealth-creation mechanisms in the US and Europe will begin to coalesce as more wealth is created onshore through IPOs, mergers, acquisitions, stock options and the sale of family businesses,” the report says. “As this wealth is created onshore, and as local capital markets offer more investment opportunities, HNWIs will lean towards reinvesting in onshore vehicles.” The report adds that North American HNWIs tend to get more personally involved in investment decisions, openly discussing strategies and seeking out information from multiple offline and online sources. Europeans focus more on reputation, brand and image while North Americans pick providers on the basis of relationships and quality of service. When it comes to judging their providers, European HNWIs tend to take a more medium-term perspective. They measure performance against a range of returns such as the interest base rate and local market indices. North Americans often benchmark against indices such as the S&P 500 or Nasdaq on a regular basis, and actively track returns against the latest performance measures. “With the greater proportion of inherited wealth, capital preservation is going to be high on the list for European investors,” explains Frank Beumer, Wealth Management Practice Leader for The Netherlands office of Cap Gemini Ernst & Young, “whereas for Americans there is a greater focus on wealth accumulation, with the US HNWI often asking ‘I’ve put in $10, now what return will that generate over what timescale?’” The primary provider paradox North American HNWIs, with a wider choice of product providers and a greater tendency to shop around, entrust an average of 60 per cent of their wealth to a primary provider. Europeans, less likely to shop around and more inclined to invest in a discretionary manner, hand over less than 40 per cent to their primary provider. On the European side, Mr Humphry attributes this apparent paradox to the mindset which says: “I’m going to have lots of little jam jars because I don’t want anyone to know exactly how wealthy I am, and how many jam jars I’ve got.” With the US, the explanation goes deeper. While Swiss private banks retain a dominant position in Europe thanks to a market built on the need for confidentiality, North American providers have developed from local brokers and trust companies. They, increasingly, are opting for open architecture. “If you can access all the products in the market through any relationship manager,” Mr Beumer explains, “it makes more sense to deal principally with the one that you have the strongest relationship with.” At present, both markets are very fragmented, with no single provider having more than a 2 per cent global market share. But, according to the report, the economy-of-scale advantages offered by global brands, research, execution, transaction processing and asset management will continue to send the largest providers in search of an advantageous global presence. To what extent they will succeed depends, says Mr Weigl, very much on what is meant by success. Global big names such as Citibank, Deutsche or HSBC would argue that they are already able to offer a broad spectrum of products and services to HNWIs in most regions of the world. But is a single provider going to be able to get a 15 per cent market share? Almost certainly not. “I don’t think you are going to be able to force that kind of switching between providers,” explains Mr Weigl. “And to achieve that kind of size through pure M&A, you would have to be spending billions of dollars.” Asset allocation It is difficult to pin down exactly how HNWIs generally allocate their assets. However, the report cites comparative breakdowns of US and European mutual funds to give a directional indication of the preferences of individual investors. European funds in 2001 put 36 per cent into equity, of which 15.7 per cent was domestic, while the equivalent US figures were 49 per cent and 42.9 per cent. Americans, as Mr Humphry points out, have been able to invest so heavily domestically because their stock markets have traditionally done so much better than anyone else’s. “If other stock markets start to outperform the US market, they may become more internationally diversified,” he predicts. “Whereas, with Europeans, it is different because no matter how your local stock market is performing, at the end of the day, you just don’t have as many local investment opportunities.” The report adds that many Americans feel they can get some international exposure by investing in US multi-nationals. Obvious examples would be global giants such as Coca Cola and Microsoft. A further twist is that European HNWIs, as well as showing a greater tendency to invest offshore, are more concerned about geographic coverage than sector exposure – the exact opposite of the American mindset. But both reflect the current trend towards investing in specialised products such as alternative investments, which include hedge funds with their strong US flavour, and in structured products, too. Future developments The two groups, despite their very different histories, are beginning to converge, and in so doing, to create a new model. “North American providers are entering Europe through acquisitions, joint ventures and organic growth, and European providers are doing the same in North America,” the report says. “Investment banks, with the central role they play in creating new onshore wealth through IPOs, mergers and acquisitions, have begun to seek a global presence in wealth management, as well.” Regulation The evolution of the European market depends inevitably on what changes are made to regulation. One example is the shift from offshore to onshore investment – more than $40bn has returned to Italy from offshore centres thanks to Scudo Fiscale, an amnesty on repatriated money. Admittedly, this is less than 10 per cent of Italians’ offshore assets, according to the governor of the Bank of Italy. But if other countries follow suit, as speculation among private bankers has suggested that Germany might do, it would take Europe a significant step further away from its traditional, offshore-orientated model. “Much has been written about EU regulatory changes promoting homogeneity in Europe,” adds Luca Piccione, head of wealth management consulting services for Cap Gemini Ernst & Young’s Italian practice. He points out that the euro has already permitted HNWIs to invest across borders without currency risk, and to achieve clear comparisons between products. The European Union’s Financial Services Action Plan is designed to achieve greater financial harmonisation by 2005, including a single market for financial services and a framework for a common supervisory structure. However, it is far from clear that everything will go ahead on the timescale planned – agreement and implementation, within the wheels of bureaucracy, both take time. As the report says: “European regulations on tax and trust specifics, for example, are likely to maintain their local bias for some time, prolonging the region’s traditional investment preferences.” Open architecture and outsourcing As HNWIs grow ever more demanding, private banks can no longer get away with offering only the products of their own asset management arm. “The danger,” believes Fabian Frohn, wealth management vice-president for Central Europe at Cap Gemini Ernst & Young, “is that if they go through a difficult period, as some large European asset managers have, and don’t achieve competitive levels of performance, then they could rapidly start losing customers.” This trend towards open architecture is already underway in the US, and European providers, too, will have to make a choice. They can choose either the role of asset manager, focusing on creating high-performance products, or that of relationship manager, satisfying a broad spectrum of needs. But, the report notes: “Separating asset management from advisory services will be culturally difficult. European providers are typically ‘universal’ banks, providing in-house services across the value chain. North American providers, in contrast, are accustomed to regarding advice as separate from money management.” The other key change to the value chain is the move towards greater outsourcing of technology and non-core capabilities or activities. Ever more important in keeping the competitive edge, scale of technology, according to the report, “remains the clearest way to lower unit costs”. Providers, therefore, are looking carefully at what they can do themselves, and what should be handed over to an expert, and third-party back-office players are evolving in response to the demand for outsourcing. The adaptive ‘private bank’ “If the back office becomes a level playing field, and any provider can access any product for its HNWI clients, then the successful player will be the one that produces the superior customer experience and becomes the expert at managing relationships with HNWIs.” The best providers will have business processes, IT systems and architecture that will adapt to fit the changing needs of HNWI clients. Mr Weigl explains: “Providers must be able to quickly recombine and reassemble business services as HNWI requirements and market dynamics change, as well as build flexible architectures that can easily leverage external capabilities from partners and outsourcing providers, and develop fine-tuned segmentations leveraging technologies to capture and respond proactively to client data.” There is an edge to be gained in terms of how a product is packaged and bundled, and there is much that private banks can do in terms of streamlining systems and cutting expenses. However, sophisticated customer relationship management (CRM) technologies are essential in order for providers to understand their HNWI client needs closely, and for segmenting their clients to serve them effectively. “Today, for example, many Swiss private banks have not implemented CRM systems and possess a limited ability to provide a 360-degree view of their clients due to a lack of customer data,” says Mr Frohn. “Also providers today are still struggling to provide their clients with an aggregated view of their portfolio across internal and external products or providers.” But no provider wanting to make a serious mark on the new, evolving HNWI market will be able to do so without differentiating itself in terms of relationship managers. The report finds that HNWIs globally will be more actively involved in their financial affairs. “Many will expect a closer relationship with their providers, and become ever more demanding about performance and clear pricing.” At the same time, with markets shaken by economic turmoil and the terrorist attacks of September 11, HNWIs are less inclined to act off their own bat when it comes to investment. They want advice and guidance, and demand a high level of expertise Thus private banks will have to meet these needs and provide relationship managers who are intimately acquainted with the market and the range of products available, keen to learn about new products and carefully trained to provide HNWI clients with exactly the information they are seeking. “I think it comes down to segmenting the customer base and working out what kind of relationship manager they want,” says Mr Humphry, “whereas, historically, we have tended to see one-size-fits-all relationship managers.” Thus he envisages a scenario whereby some relationship managers will increasingly specialise in pop star clients, others on the aristocracy, others on dotcom millionaires, and so on. Private banks in the New York market are already attracting highly educated, highly intelligent relationship managers – often ex-investment bankers, switching them from serving corporate to private clients, and paying them very competitively. London, too, is already moving in this direction; continental Europeans will have to follow suit if they are to survive in this highly competitive, highly lucrative and increasingly fast-moving market.

The key findings HNWI wealth reached $26.2trn in 2001, and just over 7m people populated the HNWI ranks; both figures rose by approximately 3 per cent. Declining GDP growth and falling stock markets were the year’s strongest brakes on the growth of HNWI wealth. North American HNWI wealth advanced slowly in 2001, at 1.7 per cent; European HNWI wealth managed only 0.1 per cent growth. Less-developed countries fared better, with HNWI financial wealth in non-G7 countries growing at 4.7 per cent, compared to only 1.9 per cent in G7 countries. The wealth of Latin American HNWIs grew by a more healthy 8 per cent, partly because they tended to invest in dollar-denominated, fixed-income products. Despite poor Japanese stock market and GDP performance, Asian HNWI wealth rose 7.1 per cent, thanks to stock market strength in other Asian countries and high savings rates. To protect their wealth, HNWIs shifted into fixed income, cash and deposit products, and physical assets (particularly property), and invested even more in alternative investments, such as hedge funds, which tend to be non-correlated with stock market returns. While the events of September 11 hit the markets when they were down, temporarily pushing them lower, their relatively quick rebound minimised the impact on HNWI wealth. HNWI wealth is expected to average 8 per cent annual growth over the next five years, reaching $38.5trn by year-end 2006. Greater similarities are anticipated in the way North American and European providers will serve their HNWI client bases. HNWI wealth managers will move towards more adaptive service-delivery models, using outsourcing and open architectures to serve their HNWI clients more effectively.