The evolution of private banking business models

Private banking and asset management business models roundtable, 8 November 2010

• Louay Al Doory, Head of Global Business Development, Reyl & Cie
• Peter Astleford, Partner, Dechert LLP
• Joe Bannister, Chairman, Malta Financial Services Authority
• Toby Pittaway, Partner, Oliver Wyman
• Guy McGlashan, Head of Products and Services, Kleinwort Benson
• Todd Ruppert, Chief Executive of Global Investment Services, T Rowe Price
• Jervis Smith, Global Head of Clients, Global Transaction Services, Citi
• Yuri Bender, Editor in Chief, Professional Wealth Management

Yuri Bender: Welcome to the discussion about private banking and asset management business models and how they are evolving following the financial crisis. Is it true to say that a lot of the issues to do with the way the business is managed relate to poorly constructed and thought out attempts at mergers and acquisitions?

Todd Ruppert: What many obsess about is growth as an outright objective as opposed to viewing it strategically, and M&A is a quick way to propel growth. However, what this does not address is the potential negative impact on culture, which can be destructive. In our case, with $439bn (€321bn) under management, our mantra must be ‘thou shalt not forget the first $439bn of valuable client assets’ and if the incremental dollar is going to cause disruption to the existing client base and culture through M&A activity, then it makes absolutely no sense to do it.

Looking at banks and insurance companies that either have asset management subsidiaries or are seeking to acquire asset management entities, there is a dichotomy. On one hand, the asset management organisation has a more predictable and desired cash flow profile and utilises less capital so from that standpoint, you have a higher multiple entity buried within a lower multiple entity. However, on the flipside, because of Basel III and Solvency II, the surplus capital might not be there to acquire someone.

So on the one hand, there is a desire to sell, meeting Tier 1 Capital or Solvency II, and on the other hand there is a desire to acquire for the attractiveness of the business. I do not know which way the industry is going to go; I would imagine there will continue to be both buyers and sellers.

Jervis Smith: For both asset managers and private banks, if you are looking at M&A, either to be divested from a large organisation or to acquire somebody, you really have to think about what the objective is and the reasons why you are you doing it. If you have a very strong, open architecture, asset allocation manager sitting within a private bank, I do not see anything wrong with that model. It is a very good model to have in a private bank

because it means having some people who are very close to the client base so they know what the clients need and what their objectives are and they can pick products from the various asset managers on their platform.

There are only two reasons why an asset management firm would want to buy another asset management firm. The first is distribution, so in other words, buying somebody that does not necessarily have that many products that you need, but who have a parent that has a good platform and a good understanding of what products might sell into their channel. We saw an example of this when Aberdeen bought Credit Suisse.

Alternatively, you buy for product which is what BlackRock did with BGI, which is they saw a macro movement going on towards cheap and cheerful index products and thought that they might as well cover a business threat, by making sure that they had that in their wardrobe as well as their active management. The management of these M&A activities is what is important and it is the execution of them that is really critical. We have seen BlackRock do it well once and there is no reason to suppose that they cannot do it well again.

Louay Al Doory: M&A is all about execution and managing culture. There are only three things that really differentiate one company over another, basically people, process and culture; that is what you have to manage.

In my previous role at UBS Wealth Management, I used to be responsible for all third party and UBS funds used within the bank, so I had a relationship with nearly every fund provider. Each provider showed me their product range and we would then decide which one would go onto our platform. We had about SFr250bn (€185bn) of product assets under management.

The real difference between manufacturers is their ability to serve the client and making an effort to understand their business model. Out of the 500-600 wholesalers that continually knocked at our door, only 10 per cent knew what they were doing. The quality of personnel in the asset management sales industry is very poor. What will be even more interesting will be when all of the hedge fund providers that develop Newcits realise that they now have to sell in the retail world.

Guy McGlashan, KleinwortBenson.jpg

Yuri Bender: Current business models for private banking and asset management are linked to fees of 2 to 3 per cent. Do you feel private clients are being scammed by the industry?

Louay Al Doory: There is a lack of transparency with fees; I would not say that it is necessarily a scam. Larger banks, by virtue of their scale and processes, are able to charge much higher fees, as it is harder to detect those fees. If you take for example a fund of funds solution, the client only sees the management fee. What is not transparent to the client is the underlying fees of the target fund, and you have even less scrupulous firms that will provide a fund of fund of funds solution that – once you actually tally the real total expense ratio – it is probably closer to 5 per cent.

Of course, there is no problem in charging 5 per cent if you have performance returns that compensate those sorts of management fees. I see the real problem comes when you charge 5 per cent and you know you will never outperform due to the weight of fees. The industry is a little disingenuous here and could certainly improve.

Guy McGlashan: The industry is still very much supply led, because when you ask any private wealth manager what one of their biggest issues is, it is about getting good quality advisers on board. It is difficult to find really good quality advisers who truly understand the full breadth of wealth management. Hopefully the UK Retail Distribution Review will address this to some extent with the requirement for higher professional qualifications.

On the client side there is a large population of individuals who are not collectively organised to put weight behind their individual views. The industry has therefore been guilty to some extent of not responding to what the client wants.

The industry has been able to get away with doing what it always has, because clients who are desperate for that advice go where the good advice is available and they will put up with the inefficiencies in the market, they will put up with the fees and whatever else they have to take as part of the proposition. As an industry we need to be on top of that.

Toby Pittaway: Even though fees look high on paper, that is not because many private banks are making huge profits; for many private banks outside of some of the very big offshore players, this is not a particularly profitable industry right now. It is fundamentally about structure of the industry, which, as you said, is across the value chain which goes all the way from advisers being rare and expensive, through to the fund structures in Europe being very inefficient compared to the US. The average cost of running a fund in Europe is almost double that in the US and behind the European Commission’s thinking on Ucits III, and Ucits IV, is an attempt to reduce that cost.

Ucits III did not manage to do that because it did not allow enough consolidation between funds. The concept of Ucits IV, with the master feeder structure, will allow that to start to happen and their hope is that that will change the potential economics from building scale to making a cross border consolidation more realistic in Europe. That is what has to happen if we are going to reduce European costs down to a similar level as the US.

Yuri Bender: Toby, I am sure that all of the private banks are knocking on your door saying: ‘Help us restructure our business model, we are having a difficult time, it is not an easy time for private banks.’ There are low costs providers setting up, charging 1.5 per cent for asset allocation, transactions and administration while the banks’ business model means charging 2.5 per cent for the full service proposition, plus other fees, so what do you advise them to do? Clients are increasingly looking at costs and thinking they can have the same, maybe even better performance through exchange traded fund (ETF) style allocation in one place, rather than pay 2 to 3 per cent somewhere else and be left out of pocket.

Toby Pittaway: That is clearly a challenge to the industry and you have to equate the fee level with the value that you can deliver and if you cannot deliver that value, you cannot charge that level of fees. It is slightly apples and pears to compare a low-cost ETF provider with a full service private bank – they are trying to do slightly different things but that competitive challenge is there and for many players in the industry, going forward that means that they are going to need to be a lot more focused in terms of what they do and they will need to really carve out those areas of the industry where they can be competitive and they can deliver that at an efficient cost.

Pre-crisis, there was far too much focus on growth at any cost and not really much thought about where they can be competitive, where they stand out, where they can add value and where clients will pay for that and that is really being reflected in the economics of the industry.

Louay Al Doory: A key trend in the industry will be a gradual migration into the discretionary world, as there is a natural focus on recurring revenues. The main reason why someone doesn’t give you a discretionary mandate is because they do not trust you enough. If an organisation says that they are seeing more advisory orientated business, it could mean that they really have client trust issues.

In the Middle East or Asia, it may take another 20 years before they develop enough trust to start doing meaningful discretionary business, which is currently negligible. In the long-term, I suspect there will be a massive discretionary business in Asia as clients become more familiar with the investment universe and develop greater trust with their advisors. At the moment, Asia is a casino, where the only game in town is leveraged property or active equity trading. If you start talking about balanced or globally diversified portfolio, you will not find much Asian interest these days.

Obviously everyone wants to follow where the money is. However, I think we have plenty of business in our own backyard. We will of course want to have a presence in Asia to allow us to slowly develop long-term relationships. Frankly speaking, I think Asia is completely overbanked and decidedly underserved.

Yuri Bender: We hear T Rowe Price is working on acquisitions in China. Do you see that expansion into the Far East as a key plank of the strategy of global asset managers?

Todd Rupert: First, we don’t comment on market rumors. We are doing quite a bit of work in Asia and we will definitely be doing more in Asia, as will many in the industry. But let me come back to where we started at the beginning. We talked about M&A activity as a way to grow in various parts of the globe, but you can also grow organically. Our overriding intention is to develop organically and not disturb the culture we have worked so hard to establish.

I am also suspect of a lot of the innovation in the industry, because much of it is just another form of marketing. I think as an organisation, whether you are a pure play asset manager or a wealth manager, you need to have a healthy degree of dynamism, but you also need to have some patience, to be able to depend upon those attributes of the organisation which have been your bread and butter that got you to where you are. I think some, unfortunately, try to be something they are not and that is where they get into trouble.

Yuri Bender: What will be the role of regulators in providing distributors and private banks with the impetus to add extra value through asset allocation, rather than just acting as a middle man and taking kick backs?

Joe Bannister: Firstly we are talking about European investors and we see two approaches to distribution which are completely different. When you said that in Italy there was pressure on the banks to divest the asset management, this is because traditionally in Europe asset management has always been through the banks and this causes a bit of concern, because banks have access to client information, they call clients and that causes problem.

The second point is whether clients acquire knowledge; however, no matter how much consumer communication is carried out, they still make mistakes. What is happening is that there is less discretionary management, there seems to be more personal fiduciary and direct interaction. The clients, perhaps at the higher level, say they want to invest in a particular country because they feel their investment is more safe.

The important issue is the interaction between the regulator and the service provider and this is now proving to be a major issue. Firstly, the service provider tends to run in all sort of directions, create all sort of products and sometimes they outstrip regulatory development, so it is important that the regulator is kept abreast of innovative products. European securities regulation may not be so comprehensive. It seems the US systems are more rigid, it seems clearer, they know what they are doing and despite certain pitfalls, it is quite tough, but it is very good.

However, the service providers remain a problem, because their training on the product they are selling is sometimes weak. Unfortunately the distribution boils down to commissions. We need to address these problems with urgency.

Peter Astleford: The regulators perform a useful role in regulating the distributor; in particular through disclosure of remuneration and through education requirements. But what there does not seem to be is any concerted attempt by regulators, government or product providers to educate consumers that paying for advice is good and, in particular, that paying by fee, rather than by commission, is better.

Ultimately, the question that I worry about, particularly from a UK perspective, is whether, in the future, there will be enough educated distributors who can properly advise, with knowledge and who have the right mentality and approach. Indeed, is there enough perceived demand for these people? That is the thing that nobody seems to be addressing.

I had an interesting talk recently with a very senior official from Brussels and he was basically addressing the industry and said: ‘We do not like what you are doing, we do not like the way that you go about it,’ and that goes for the G20 as well, which absolutely does not like the way the financial industry runs itself and, if there is any confusion, the general public hate even more what you are doing.’

That says to me that there is going to be a climate of increased rule and regulation for the foreseeable future.