As a tidal wave of regulations combines with economic pressures, swirling up in a storm further fuelled by a new awareness among consumers of investment products and services, both the factories building and designing funds and the private banks who package them up with advice for their wealthy clients are being forced to change their game.
With the once powerful banks being increasingly split into hapless, weaker standalone divisions by the same regulators who are demanding that clients be told exactly how much they are paying for products of variable quality and accompanying advice, both distributors and manufacturers cannot take the developments lying down.
In fact some are even seeing the wide-reaching changes sweeping through the industry as a huge opportunity. Forward-thinking fund houses are now teaming up with like-minded banks to reach even deeper into the asset pools of unsuspecting private clients.
“The whole asset management industry in Europe is in turmoil,” admits Emanuele Ravano, head of the London-based global wealth management team in Europe for US manager Pimco, best known for its star fund managers and top performance in fixed income classes.
“You get the sense that the discretionary channel has pushed as far as it can go and advisory is where future success will be built.”
Conflict looming
This simple conclusion draws future battle lines in the industry, with those banks continuing to cling desperately to the high-fee model of discretionary portfolio management already beginning to doubt their own wisdom. Others are looking to redefine their advisory offering so that the relationship with clients is not such an offhand and occasional, low-fee, transactional link.
Success in advisory channels and platforms, where it pays to promote only a handful of high conviction ideas, the dishes of the day rather than the full fund management menu, is a different business to the discretionary sector, believes Mr Ravano.
The intense dialogue his team is conducting across Europe with both retail and private banks, visiting country and department heads, sales forces and regional bankers, is however targeted at a much smaller number of partners than in previous years.
“A lot of banks are still recommending more products than any investor can possibly suggest,” shrugs Mr Ravano. “We prefer those who have a clear limitation to their product offering. If you want to offer something digestible, you need to partner with just a few banks and really commit.”
Regional penetration of every hub and spoke of a target partner is crucial. “It’s not just about performance any more,” suggests Mr Ravano. “You need to be present, supporting sales forces in a regional context. If you are working in Italy, it’s not enough to just be in Milan. You need to be local in Rome, Naples and Verona.”
The conversations with these regional representatives also need to be much more open than in past times. Fund manufacturers need to be spilling the beans about next year’s products to distributors, while they do their best to offload some of the current flavours of the month.
“You have to keep the insights coming to the banks,” says Mr Ravano. “We are now discussing products with them that we will be launching in the second half of the year, or even at the start of 2014,” he says. “This keeps the partners more relaxed, as they know what is happening on the products side.”
Rather than shower these distributors with a vast array of available strategies, the trend today is to market just a handful of products, in which the manufacturer has ultimate belief.
“Markets in Europe are in such a state of flux that very few private bankers are able to concentrate on value added to the client,” says Mr Ravano. “But when they actually do that, the pay-off can be huge. You need just a few bullets you can use wisely, not a whole arsenal. If a banker says: ‘I have two investment ideas, but they are relevant to the times we live in,’ then client responses can be off the chart. But too few banks are focused on this.”
Carefully chosen
This approach is particularly favoured by the Société Générale group. Several themes have been distilled by the Paris-based investment team and are then highlighted to clients through regional outlets. These currently include increasing allocations to the US high yield sector, buying into energy intensive stocks and gradually stepping up weightings to European banks.
“When you have an advisory relationship with the client, you really share the investment idea, the vehicle you select and the product details,” says Eric Verleyen, chief investment officer of SocGen’s London wealth management arm, SGPB Hambros.
Having studied the most profitable and effective business models for future growth, Mr Verleyen is promoting the ‘advisory managed mandate’, which allows for bankers to call a client every time a major investment decision affects their portfolio.
“Private banks certainly have to be more flexible, now that there is increasing competition from family offices,” he suggests. “To go along with the old solution of ‘we will just stick it all into DPM [discretionary portfolio management] is no longer credible. We need to adapt to the situation and have more dialogue with clients.”
It is clearly not easy to foster such a relationship in the current climate, with many wealthy individuals evidently falling out of love with their wealth managers. One answer is to try and lure the next generation of clients, while their parents are still on a bank’s books.
ABN Amro is one of several banks to have put together their own ‘Next Generation Programme’ aimed at the offspring of wealthy investors, typically in the 25-plus age bracket. “We bring them together, update them about trends and developments in the financial industry and offer them a platform to get to know other sons and daughters of wealthy parents,” says Jeroen Rijpkema, CEO of ABN Amro Private Banking.
“We encourage them to discuss what it is like to have wealthy parents, as it is not always a blessing and can bring expectations and obligations with it.”
But the banking giants, despite all their clever innovations, may be losing ground to new competitors among boutiques, private and multi-family offices, believes Lorne Baring, formerly a high-fee earning private and investment banker at Barclays Capital, who recently set up his own B-Capital wealth advisory shop.
Mr Baring’s theory is that only those clients who wish to keep money on deposit or in low-risk products keep the majority of their assets with large private or universal banks. Wealthy individuals who seek higher returns from riskier investments would typically do this with a boutique or private investment office, believes Mr Baring.
Battered reputations
Banks currently have such a poor reputation that few are trusted with investments, he adds. “What if I am looking for a bank to help me with managing my money and I read the news about crazy rogues traders, Libor fixing and banks in trouble with the US tax authorities?” asks Mr Baring.
“This leads to many investors just wanting to sit on the sidelines, with a German bund or two, for a few years. They may feel they are already facing enough risk in their own family business.”
Increased regulation also means most private bankers follow a centrally-devised script regarding asset allocation and products, while compliance costs are spiralling. Complex products, lacking liquidity, transparency and control have also alienated clients. Banks are unable to reach deeper into clients’ pockets or increase their “share of wallet” using such a model, believes Mr Baring.
“Banks have offered ‘mumbo jumbo’ products that promise if the yen goes one way, the Korean won another and UK inflation follows a particular pattern, then you get five times your money,” he says. “These offer no liquidity, transparency or control.”
At B-Capital, Mr Baring promises clients they can liquidate 90 per cent of their portfolio within minutes, with no pricing disadvantage. This means exchange traded funds need to be a key component of portfolios.
Addressing shortcomings
All of these claims are backed by Amin Rajan, CEO of the CREATE-Research consultancy, which conducts regular surveys of wealth management groups. While the discretionary model restricts much-needed contact between banks and clients, the advisory channel has a tendency to highlight unsuitable products.
Correcting this flawed delivery mechanism is a key challenge for private banks, he believes. “First, they need to improve client proximity in order to understand clients’ dreams and nightmares, sell products that clients need, elicit regular client feedback and avoid unrealistic claims about returns,” ventures Mr Rajan.
The assessment of banks’ brutal shortcomings on the investment side is equally scathing. “They need to improve investment capabilities in order to develop insights into the geo-politics of debt markets, identify return drivers during different volatility phases and isolate value traps from value opportunities.”
Not only do banks need to fundamentally change their distribution channels and investment processes in order to regain the trust of clients to improve market penetration, but they also need to improve alignment of interests with clients. “This can only be done by adopting meritocratic fee structures and selling products that are fit for purpose,” argues Mr Rajan.
Even with regulations such as RDR (Retail Distribution Review), supposed to empower consumers, being adopted in the UK and about to sweep through Europe, although a sea-change to business models is overdue, it is far from inevitable, certainly before the end of the decade.
“The old commission-based model is so deeply entrenched that unravelling it will be a slow process, while legacy assets are locked into it,” he adds.
Banks can make some progress themselves by identifying several key investment themes and basing their offering around those, but they have led their clients down so many blind alleys in the past, that there is a danger any new direction might be viewed as a marketing gimmick by war-wary clients.
“Lately, high conviction investing has been gaining traction, albeit slowly,” says Mr Rajan. “But investors need to be sure that it works, as they have lost faith in active management over the last decade. We are seeing more ‘go-anywhere’ type mandates in the private wealth world, but their incidence should not be exaggerated.”
Indeed, there is an increasing acceptance in the investment world that necessary changes will not come from accountancy measures, imposed by private banks’ finance departments, but through practices encouraged by a new generation of leaders at the helm.
“You can talk until you are blue in the face about margins and cost-income ratios, but the main determinant of success of a private bank or asset manager is the people,” says the head of wealth management at a major European institution. “Who is at the top and which lieutenants do they put in place in key positions?”
