The increased demand of clients for more individual advice and risk management will only be met if wealth managers define their offerings far more precisely. This article points to the shortcomings in the industry and what can be done to deal with them.

The stock market rally has brought a welcome return of investor confidence and a much needed boost to the wealth management industry. The big question for the industry, however, is whether the pain of the last two years will be rapidly forgotten, or whether there are enduring changes in client attitudes which will have a fundamental impact on the type of service they require.

Investors have been deeply shocked, not only by the steep (if temporary) downturn in the market, but by the near collapse of the banking system and by a series of scandals which have inevitably eroded trust in investment professionals. Clients mainly recognise that exceptional circumstances left most advisors floundering, but the crisis has impressed on many investors the need for a mature and experienced advisor who helps them with the big decisions, rather than a salesman who merely   helps them select product.

There have indeed been numerous reports of clients going over the head of their relationship manager to seek advice from more senior people, with more experience and wisdom. Many also have a strong sense that their investment manager is more driven by concerns over his own performance track record than by the interests of the client and that the big asset allocation decisions are driven by corporate policy rather than a carefully developed analysis of the client’s particular circumstances.

Search for trusted advisor

One of the lessons of the recent crisis is that individual circumstances became far more crucial to decision making, as crude risk categorisations became irrelevant and client risk tolerance (as conventionally measured) was continually changing. This applied especially to clients with more complex circumstances, whose assets included private business interests.

So whose judgement should the client trust and what exactly is the responsibility of the investment manager or wealth manager? Who exactly makes the key decisions - the investment manager or the client or a combination of the two?  Is the client effectively buying an investment product dressed up as a tailored service or is the investment manager a true trusted advisor?

There is, of course a variety of different models, ranging from traditional stock broking to private banking and wealth management, but the boundaries between these different offerings became very blurred during the bull market when everyone made money. There are indeed many advisors whose brochures and publicity material suggest a quality and depth of individual service which is far beyond reality.

The need to clarify these relationships seems increasingly urgent as more and more clients ask themselves who they can trust, after a catalogue of unthinkable incompetence has damaged their confidence in the entire financial services industry.

Market crashes lead to innovation

Bad experiences tend to be a catalyst for change and perhaps the most fundamental post war innovation in private client wealth management came in the wake of the recession of the early 1970’s. The FT index fell from around 500 to only 150, in response to a combination of a huge spike in oil prices and industrial strife in the UK (older readers may remember the three-day week).

The fundamental innovation was the transition of private clients from the traditional, transaction based stock broking model, to the investment management model, in which fees are charged as a percentage of the portfolio. In return, the investment manager takes responsibility for the performance of the portfolio and it may surprise many investment professionals who have grown up with this concept that it was once seen as a brilliant new idea!

New terminology hasn’t always meant new services

There have, of course, been many changes since the early 1970’s, including a massive extension of the range of products, such that the industry has had to adapt to a far more complex set of choices, which have tested the expertise of all managers.

The basic investment management model remains in place, but is now being questioned and private bankers in particular are too often seen as product salesmen, rather than people in the position of trusted advisors.

In part this perception of product selling results from the fact that the management of portfolios has become more standardised and thus less individual, for a number of reasons:

·       Performance measurement and benchmarks lead to index-hugging.

·       Regulation requires providers to demonstrate that all clients have received similar advice.

·       Diversification requires more and more specialists, inevitably more distant from end client.

·       All providers seek to make the business more scalable, spreading their expertise more thinly.

·       As more and more decisions are removed from the relationship manager, he becomes a mere mouthpiece for the organisation.

Whether or not these developments have improved the service to clients is highly arguable, but the trend towards a product sales and distribution culture is well recognised among industry participants and there have been a number of attempts to address the problem by promoting a client-centric relationship model:

Private Banking

Private banks begun to become a major force in the market about 15 years ago as retail banks around the world opened private banking subsidiaries. Their mission was to deliver more personal relationship management and to offer a one stop shop, whereby the client’s private banker was their trusted advisor across all aspects of their financial affairs. Because of this broader perspective, he or she would have a better understanding of the client and thus be more client centric than the traditional investment manager - in theory a very attractive proposition, especially for those with a diverse range of assets.

Open architecture

To further counter the product sales accusation, private banks and others began to promote “open architecture”, the purest version of which means that the provider uses 3^rd party product only. His proposition is that he adds value through asset allocation and in the selection of third party managers, usually adding the argument that the asset allocation accounts for 90 per cent of performance.

There are several conceptual questions about this model, the most important being that if the outsourced part of the proposition accounts for less than 10 per cent of performance, does it really make the manager more aligned with the client when big decisions have to be made? Furthermore, if asset allocation is the main activity, it is quite difficult for some clients to understand what the manager actually does all day to earn his substantial fees.

There is indeed a danger of such managers overcomplicating their role to justify their fees, at a time when clients are looking for an advisor with common sense and who is able to express himself in straightforward language. Unnecessary complexity and excessive use of industry jargon such as “tactical asset allocation”, “alpha” and “beta”, far from impressing the client, can suggest that their wealth manager is on the wrong side of the table.

Wealth management

The term “wealth management” has been used increasingly over the last decade, again with the intention of combating the image of product sales. This term, rather more explicitly than private banking, seeks to portray a true trusted advisor relationship where the advisor has input across all aspects of the client’s affairs. The problem is that, except in the most straightforward cases, it is extremely difficult to deliver, especially for clients with private business interests and complex arrangements. For more sophisticated clients, it is quite obvious from the moment they meet their prospective wealth manager that the relationship cannot possibly reach the depth and breadth promised in the brochure.

Some organisations are even going one step further in using the term “family office” to cover what in practice is little more than personalised asset management.

Time to define the offerings

Exaggerated claims of expertise do little to create trust and indeed often damage confidence in the core service on offer. The continued search for new terminology and labels seems to suggest a sector trying to re-invent itself and distance itself from the past, perhaps realising it does not always deliver what it promises.

There will rarely be a better time to find out what clients need, because the pain and uncertainty of recent years has focused their attention on the flaws in their current arrangements, which go unquestioned during a long bull market.

Current indications are that many clients are beginning to buy into the concept of wealth management proposition much promoted by private banks, but are still looking for a wealth manager who matches up to the description.

In particular, the more complex and sophisticated clients are recognising the following:

·       Much more attention needs to be paid to the development of a clear strategy for their overall wealth, without which it is impossible to define and evaluate risk. This can be a substantial  task akin to a management consultancy project, which goes far deeper than the ‘know your  client’ processes of a typical investment manager.

·       The measurement of risk has been far too focused on volatility; risk needs to be defined from the personal perspective of the client. In rapidly changing circumstances, a deep understanding of the client side is required, as attitudes change in response to events. Crude risk categorisations can often become totally inadequate.

·       There is much greater need for co-ordination between high-level asset allocation decisions and other aspects of their affairs. Some understanding of their broader affairs and the risks they entail is essential.

·       In families clearer, better defined decision making processes and governance are required, to ensure differing risk perspectives of all family members are fully considered.

·        A much better and more precise understanding is required of the entire chain of parties involved in their investment management and the respective responsibilities of each.

·        They need one overall advisor genuinely on the client’s side with whom to debate major decisions.

In short, they want an advisor who explores the issues from a client perspective, before turning their attention to the management of the investments, the latter being a subset of wealth management. One investor even described this person as an “anti investment industry investment advisor”.

Clearly this is obvious for complex families with extensive business interests, for whom managing investments is far from being their first priority. But even relatively straightforward clients are looking for a more genuinely client-centric approach.

The underlying question here is whether and at what point individual advice actually adds value or whether, as the standardisation of private client portfolios implies, a portfolio can be run entirely satisfactorily with a relatively superficial understanding of the client, such as can be evidenced by a completed KYC questionnaire. In other words, the in-depth understanding implied by wealth management brochures adds little true value and is really window dressing to build client loyalty.

The answer lies in far tighter definition of the offering, explicitly stating the benefits and the responsibilities of each party.

Investment managers, for instance, should state whether they are essentially offering a standardised portfolio with personalised relationship management or whether they genuinely construct individual portfolios, based on a deep understanding of the client. If the latter, how exactly does it differ from the former and what additional skills are required to deliver it?

Private banks and wealth managers need to explain satisfactorily how their offering differs from investment management. They must state far more explicitly, for instance whether their responsibilities to the client extend beyond the investment portfolio (as often suggested in the brochures) and how this responsibility is discharged in practice. If they really claim to offer trusted advisors, they need to field relationship managers with the breadth and depth of experience to be credible in this role.

All of the above is well understood by the industry leaders and the most recent PWC survey of private bank chief executives suggests they acknowledge a substantial gap between the perceived needs of their clients and the advisory skills of their relationship managers.

Unfortunately it seems most private banks are not planning to do anything about it as the survey clearly identified sales training as the prime development need, a finding which seems to confirm the fears of many clients.