Scott Mcculloch is editor of Families in Business magazine.
The ranks of the world's super wealthy have grown steadily over the past year, says Scott McCulloch. Now all the private banks must do is calculate how to serve them best and do it at a profit
Private banking is for the rich, not merely the comfortably off. Fortunately for the banks there are more moneyed people about these days. Some 7.7m individuals had assets of more than $1m at the end of 2003 – 500,000 more than 12 months earlier, according to the Merrill Lynch/Capgemini World Wealth Report. Combined, their assets totalled $28.8bn – a tidy sum grown on the back of stronger-than-expected economic upturns in North America and Asia, and the revitalisation of global financial markets.
The super wealthy – clients with tens or even hundreds of millions in liquid assets – have long been an obvious target for private banks. Now, even more so. Private banks and trust companies pride themselves on making all their clients feel special. But some are more special than others. Growth in the number of super-wealthy individuals (their ranks in 2003 soared by 14% in the US alone) has forced new gradations of sycophancy.
Consequently, a growing number of wealth management firms are creating new business groups to target them. Customers who once got top-tier treatment with $5m-10m can suddenly find themselves gently knocked down a peg. More than $10m will get you into Merrill Lynch's Private Banking and Investment Group. But this is not enough to warrant the firm's family office services, which manage your entire financial life, including paying the bills, unless you have about $100m.
Private banks worldwide have $5.3trn of wealth under management, according to Scorpio Partnership, the wealth strategists. That is a penetration of 18% of the rich globally, significant but small. So private banks are not exclusive players in managing personal fortunes, although the industry would like to think different.
What is more, high net worth individuals looking to get a long-term lock on their lucre are happy to do it under their own steam. The scale of the problem for private banks in some markets is illustrated by research showing that 32% of Britain's wealthiest private investors take no professional advice when making investments. These investors, with a minimum of £250,000 in liquid assets, rely wholly on their own investment skills, according to Tulip Financial Research reports. Tulip's managing partner John Clemens says his firm's survey shows that just 16% of Britain's richest private investors call on a private bank for advice, although 45% have an account with a private bank. The research organisation also found that 'do-it-yourself' investors were the wealthiest of wealthy holding on average £980,000 of liquid assets, whereas advised investors held a lot less, on average about £650,000.
Although Clemens says Britain's super-wealthy are accustomed to dealing with finance, he cautions: "That's not necessarily investment, but finance." He says a number of high net worth individuals may falsely believe they are thoroughly knowledgeable or capable of investing themselves. "They think they know about money, and so they have what might be a slightly over inflated opinion of their ability of how to invest, but actually they just do not trust formal investment advisers."
What's on offer
That means that on the advisory front private banks have their work cut out. Debra Treyz, head of JP Morgan Private Bank for EMEA, says the market is such that there are "too many players chasing too few private clients" adding that private banking is a "woolly term" defined by one certainty – it refers to individuals not institutions.
Bruce Weatherill, global leader of wealth management services at PwC, warns that private banks should be wary because wealth managers can underestimate the demands placed upon them by ultra high net worth clients. As their numbers have risen worldwide so has their level of sophistication and financial requirements, goes the argument. Merrill Lynch/Capgemini's world wealth report notes the trend for the super-wealthy to behave increasingly like institutional investors, expecting portfolio risk management, dynamic asset allocation and objective investment. "Once you move up to the higher net worths, you're actually dealing with quasi-corporates who are being bombarded by lots of sophisticated products," says Weatherill. He believes a number private banks fall short of achieving a deep understanding of their clients' investment needs and high level of sophistication. "I think the bigger banks, the big Swiss banks and some of the UK players probably don't underestimate [their clients]. Their issue is making sure the right person gets in front of the client. I think the organisations in the most trouble are the mid-tier private banks that are trying to be global, and trying continually to compete with the big players."
Alvi Abuaf, a vice president at Capgemini, says the emphasis has shifted from the preservation of capital towards an "accumulation and distribution" of wealth. Wealth management has become multigenerational, which has created strong demand for services centred on tax, estate and philanthropy planning services. "Many ultra-wealthy families are creating 100-year plans, in which family members are treated as business divisions and emphasis is put on corporate-inspired guidelines," he says. This rings true with JP Morgan's Treyz, who likens her bank's private clients to institutions "with arms and legs".
Yet some private banking critics believe the modern trend is for the super-wealthy to make their own decisions on investments, with relatively little recourse to professional advisers of any kind. Treyz believes that private banks that try to "be all things to all people" are not doing themselves any favours. By all, she means retail, affluent, high- and ultra-high net worth clients. It's a classic case of Jack-of-all-trades, master of none. "You often can wind up with a service that is either too tailored and expensive for less wealthy clients or too narrow and product-focused to meet the complex needs of very wealthy families," she says.
That jives with wider opinion from banking critics. In a recent report on private banking, Ruwan Weerasekera, a partner at management consultant Accenture, said: "A lot of wealth management providers were offering a wide range of different services to customers, but these were not necessarily better services that had been offered before. This meant that when markets started performing badly and institutions were losing money that these services were the first to go."
With the super rich becoming increasingly wealthy, private banks are competing for the business of a growing number of potential clients. JP Morgan Private Bank recently marked the 100th anniversary of a relationship with a particular family. Treyz says her organisation is one of the only private banks that has always focused exclusively on the ultra high net worth market and has catered to the needs of that specific group since the days of John Pierpont Morgan – the banking and art collecting figure who worked with the family dynasties behind the railroad and steel fortunes in the US. Meanwhile, Coutts & Co, the 300-year old UK private bank, has a long-standing relationship with its most exclusive client, the British royal family.
Coutts, which is now part of RBS/Natwest, is aggressively trying to expand its business. Having spun off its merchant banking activities, London-based Singer & Friedlander has identified asset management as its core business. By contrast, Rothschild sold its asset management business to Insight Investments and brought fund management back into the private client division.
Meanwhile, the growth in alterative investments is one reason why private banks in the US are getting bigger. The leading private banks there are trying to position themselves as guides to the hitherto unregulated, often bewildering world of hedge funds, sifting through thousands of offerings from outside firms, thereby adopting a so-called open-architecture model. Many have begun offering their own products – typically funds of hedge funds. The irony is that alternative investments, which can include foreign currency and commodities, are now mainstream. They are popular too. By 2003 European investors had more than doubled their average strategic allocations to hedge funds. Why? Wealthy clients in Europe, Asia, Latin America and the Middle East found hedge funds and structured products a canny strategy, netting average returns of 19%. That same year, alternative investments accounted for 13% of holdings among the super rich, up from 10% a year earlier, according to Merrill Lynch/Capgemini.
Shifts in asset allocation strategies aside, the greatest challenge for private banks going forward may well be matching financial wits with their rising number of well-heeled and well-read clients. The good news is that they are in better shape. Pre-tax profits in the sector rose an average 46.8% on a global scale in the first half of 2004. Having tinkered with their business models and cut costs, the banks are now more efficient, say experts familiar with the sector. But it has been their agility in converting recent increases in assets under management (AUM) into profits that has impressed some. Higher AUM levels, says Scorpio Partnership, reflect the growth in the equity markets over the past year and, to varying degrees, the net new money received from existing and new clients.
With equities rising to 35% of all holdings (up from 20% in 2002) the super-wealthy were among the first to shift their focus from low-yielding fixed-income securities and back into stock markets. And just what kind of tips are the well-heeled getting? JP Morgan Private Bank, for one, put the word out as early as February 2003 that it was time to get back into stocks. The call proved prescient; the Standard & Poor's Global 1200 index has moved up 50% since.
First class service
Private clients can still expect the red-carpet treatment from their banks. The decline in total private banking personnel is over and the number of client-facing employees has increased by 7%. This, says Scorpio Partnership, reflects the selective pattern of hiring that the industry has adopted, a strategy it believes could also lead to an influx of 'quality new assets'. "Private banks are once again staffing up to gather new assets," says Sebastian Dovey, managing partner at the research group. "Unlike the late 1990s, the emphasis will now be on quality distribution and the assets should be stickier. This is because the increasing adoption of open architecture (where a bank deviates from its own brand for appropriate investment products) combined with better mid- and back-office processes, means private banking clients are getting what they need, not what the banks think they want."
Perhaps the private banks can turn to Clemens, who has an intimate understanding of people with bulging wallets. Those with high levels of liquid assets, he says, tend to be old and have spent a fair bit of time in senior level business positions. So are they better positioned to advise themselves than their private bankers? "That is probably what they believe, but that is probably not true," he says with a flourish. "I don't actually think that most wealthy people are particularly canny investors."