Taking time to reflect

Let us turn the clock back 10 years, to when PWM was being launched in 2001. Following the arrival of the euro, American institutions in particular started to view Europe as a virgin market of growing numbers of wealthy individuals, hungry for risky capital markets product created by investment banks. Similarly, local European banks such as UniCredit, Commerzbank and SocGen began to market derivatives such as warrants directly to wealthy individuals in neighbouring countries.

Swiss banks, at the same time, began to refocus efforts on asset allocation, dogged by real worries that a combination of tax amnesties, a proposed new withholding tax and increasing attacks on secrecy, would force them to fully redraw their value propositions.

Institutional asset managers, on the other hand, were busy spinning off wealth management arms to leverage strategies, once exclusive to the world’s largest pension funds and central banks, for distribution to high net worth and mass affluent markets.

These three simultaneous trends converged to hugely increase the scope of products and services available to wealthy investors.

Of course, all was far from rosy, as these changes were taking place against a background of terrorist attacks on New York and Washington DC. These caused mayhem in world markets and heralded a new political order in which the US was no longer able to call the shots, either militarily or economically.

Also fast becoming evident was the lack of the sophistication in the private wealth world, allowing private clients to be exploited by investment bankers. Like many colleagues, Michel Meert, now head of wealth management EMEA at consultants Towers Watson, was moving from the institutional to the private wealth world in 2001 and was surprised by what he saw.

“I wanted to use the technical skills of the institutional world in private wealth,” recalls Mr Meert. At the time, French groups such as Axa and CDC Ixis were keen to bring pension fund-style disciplines to the top end of the retail market. “But it was a huge disappointment. Private wealth was simply not ready for this.”

DISTRIBUTION PARAMOUNT

There was much institutional-sounding talk about “innovative” strategies, “balanced” funds and “multi-style” investments. But in reality, many portfolios were altered and managed not for the benefit of the clients themselves, but for the banks issuing the products. Unlike the institutional world, where emphasis was firmly on managing investments, distribution of funds rather than their actual performance soon became the real benchmark of success.

Despite all the trendy talk of “open architecture” – the use of best products from the vast universe available, to improve results being demanded by increasingly financially literate clients – the reality of product selection remained starkly different to public claims of the banks in Europe. Banks continued to stuff private portfolios full of house-produced funds, says Mr Meert, particularly those charging higher fees.

But there were stirrings of change in Germany, where Deutsche Bank, Deutsche Postbank and Frankfurter Sparkasse began to sell Fidelity’s European Growth fund in 2002. “We thought it was Christmas,” said an incredulous Thomas Balk, then Fidelity’s European business boss. “Deutsche Bank came to us and said: ‘We want to sell your funds’.”

This shock move was only an appetiser to what the German powerhouse would do next, introducing the “guided architecture” model, following a parallel move from cut-throat competitor Commerzbank.

An A-list of partners – including Fidelity, Franklin Templeton, Invesco, Schroders and UBS – were signed up to offer exclusive advice to the bank’s private clients. Bosses at the in-house funds arm were not best pleased, with some complaining about Deutsche having “invited strangers into the bedroom”. Yet they eventually calmed down when they found out only products in particular sectors would be outsourced. Where there was any doubt at all, DWS funds would have supremacy.

Perhaps the strongest move towards use of third party products happened in the UK, where James Bevan, the highly-intellectual investment boss at fading bank Abbey National, outsourced his entire £30bn (E35bn) portfolio of customer investments to some big brand external managers at the beginning of 2004.

But even as the open architecture movement picked up steam mid-decade, there were enough vested interests to kick it in the shins every time there was an economic downturn. Some banks such as Dexia, publicly refused to sign up, saying their own products were so good that third-party strategies were simply not needed by their clients.

And looking at its legacy today, observers would be forgiven for thinking that, just like the feminist movement in the 1970s, the revolution had never actually taken place. “If we look at where we are now, the trend is diminishing,” admits Mr Meert. “There is a bit of open architecture around the fringes, but internal products still dominate, as they are the most profitable.”

Today hope lies with some boutique firms, starting to manage privately-held assets institutional style, focusing on providing dividends to match liabilities, rather than distribute populist products. This new approach makes use of increased European issuance of exchange-traded funds, which helps vastly reduce the cost of managing portfolios.

While old-school Swiss names, including the likes of Pictet and Lombard Odier, have always managed money in this fashion, some of their larger competitors began to see private banking simply as a cash cow, with investment committees of banks under huge pressure from management to keep churning model portfolios, in order to stimulate product sales.

“Management were often furious because my investment decisions were not generating enough revenue for them,” recalls one browbeaten former chief investment officer.

Back in the summer of 2006, then UBS CEO Peter Wuffli hailed the attractive economics of the wealth management business, as the most profitable industry for global balks, offering the most sustainable margins, possibility of generating recurring revenues and golden combination of low capital requirements and high barriers to entry.

This followed a stark warning from Zurich’s best-known M&A consultant Ray Soudah, that any institution which cannot achieve a share of between 5 to 10 per cent in wealth management, outside their home market, should sell up while valuations are good and put the resources to more profitable use.

LOOKING TO THE EAST

The comments prove prophetic as institutions struggled to profitably re-invent themselves once the crisis begins to bite in 2008. European fund distribution markets all but dried up and contamination from investment banking spread through global houses such as UBS to unsettle wealth management clients. Asian expansion became the new Holy Grail as European prospects faltered and Western groups tripped over each other to sign joint venture partnerships in China.

Despite significant client losses since the 2008 crisis, few have significantly changed business and delivery models. UBS remains the best example of the integrated bank, although internal spats about future strategy led to the recent resignation of CEO Ossie Grübel. What has changed most significantly over the years is the composition of investor’s portfolios.

After a lot of head-scratching following the 2000 to 2002 bear market, a mini-boom in multi-asset investing resulted, believes Rupert Robinson, CEO of Schroders Private Bank. “Most investment firms did not do a good enough job preserving wealth during that period,” he says, with 50 per cent losses in equity portfolios common at the time.

This led to inclusion of a whole new set of assets, including hedge funds, private equity, property, structured solutions and commodities, unfortunately triggering further problems when due diligence procedures were not properly observed.

The majority of Swiss banks, admitted to unwittingly investing private clients’ cash into the fraudulently-run Madoff funds. The business of UBP – which had a €660m exposure – subsequently shrunk from being the world’s largest fund of hedge funds player running $60bn in 2008 to a low point of $25bn in 2010.

Since Madoff, private banks are imposing more central control over advisers, preventing them from going “off-piste” with favoured clients and updating them regularly about which investment products are on the group’s officially-validated list.

Thematic investment has also taken off among Swiss banks looking to attract dissatisfied clients back into the fold and emerging market equities finally began to make the transition from the satellite fringes to the core of private client portfolios. The prolonged bear market following the crisis of 2008 led to further investment lessons, says Schroders’ Mr Robinson, with bankers learning that strategic asset allocation should become more of a practical rather than academic exercise. Real return forecasts over a 100-year time period are now being shelved in favour of portfolios constructed over 5 to 7-year time frames.

Despite the rise of the boutiques, such as Schroders Private Bank and the success of Julius Baer’s “pure play” private banking model, where there is only wealth management and less pressure to sell structured products and funds, the most successful players remain the global banks.

Both UBS and Credit Suisse continue to exploit synergy between their three divisions to cross-sell, while HSBC concentrates specifically on recruiting private banking customers from within the group, the so-called “low-hanging fruit”, rather than waste energy scouting for external clients.

According to Martin Engdal, head of European business at US software developers Advent, it is now private clients themselves rather than the institutions who service them, which are starting to drive the wealth management agenda.

The client, he says, is supported by European regulation such as the Mifid directive, although many banks are succumbing to regulatory fatigue, no longer able to distinguish which regulations are worthy of the paper they are written on. Mifid is supposed to ensure advisers understand products and are educated in what the client needs. The main blockage in the distribution channel is all to do with a lack of implementation of technological solutions rather than poor quality of products, he believes.

“Our industry has not yet caught up from a technology standpoint,” says Mr Engdal. “Advisers still speak to clients mainly on the phone, whereas the majority of clients want to communicate electronically through smart phones and iPads. Wealth management firms are not geared up to these needs yet.”

PWM’s dates with destiny

December 2001

Institutional investing has matured, claims Schroders. Future profits will come from distribution of funds and private banking products to European high net worth clients

April 2003

‘Guided’ architecture born as Deutsche Bank chooses eight external fund houses to provide products and market information to customer

November 2003

Mutual funds probe by New York attorney general Eliot Spitzer gathers momentum. Mr Spitzer eventually elected New York Governor, but resigns over prostitution scandal

January 2004

Sea-change in outsourcing wealth management as James Bevan, investment boss at Abbey, farms out running £30bn (E35bn) in assets to the likes of GSAM, Axa and JP Morgan

June 2005

PWM and BNP Paribas host first of European Fund Series of events across Europe, examining the transformational implications of Ucits III directive, allowing derivatives to create absolute return strategies

October 2006

Credit Suisse economist Philippe Vorndran tells PWM readers that Silvio Berlusconi’s mismanagement of economy could lead to Italy’s eventual exit from the euro

April 2007

Warning about emergence of derivatives-led, Las Vegas-style “Supercasino” of products, posing dangers to the financial system, from Cass Business School Professor Keith Cuthbertson

August 2007

BNP Paribas Investment Partners suspends three funds with exposure to US sub-prime to protect investors, spooking global markets

July 2008

UBS reports SFR19.3bn (E15.7bn) of outflows in the first six months of the year following sub-prime related write-downs

October 2008

Launch of PWM Asia edition

April 2009

Switzerland put on “grey list” of tax havens by G20 conference, heralding end of era of Swiss banking secrecy

April 2010

Vast expansion of onshore Ucits III funds aiming to imitate investment strategies of offshore hedge funds

March 2011

Tokyo earthquake and tsunami, combined with geopolitical shocks and Arab revolutions lead to renewed emphasis on tactical investing by private banks

October 2011

Private banks re-assess use of ETFs after UBS trader loses $2.3bn (E1.7bn), leading to fraud charges and precursor to resignation of CEO Oswald Grübel