Gone are the days where a private client adviser can simply quote the performance of the Australian Stock Exchange’s top 50 stocks to the cl...

Gone are the days where a private client adviser can simply quote the performance of the Australian Stock Exchange’s top 50 stocks to the client and take the rest of the day off. This will be no surprise to most since foreign banks now have 20 years of accumulated experience in Australian private banking. Private Client Management has interviewed senior private banking figures and has found the uniquely Australian characteristics of high net-worth individuals are forcing structural and cultural change within an industry going through some major tremors.

Recent experience

“There are a lot of offshore firms who weren’t here ten, even five, years ago, but in the last six months there has been a real shakeout,” said Clark Morgan, deputy chief executive at UBS Warburg. Merrill Lynch has closed its operations, Charles Schwab exited the market, JP Morgan Chase sold out to Dicksons, a Sydney private client stockbroker, CSFB sold out to Challenger and BNP Paribas sold out to Macquarie.

Tony Bates, financial adviser at DFS Financial Services, and formerly head of private banking at Macquarie between 1994 and 2000, paints a similar picture. “European private banking models have tended not to work here. They have been tried and have failed,” he said. Twice, in the 80s and 90s the overseas banks came and twice beat the retreat. UBS, Deutsche, ABN AMRO and even an Italian private bank had all entered the market with European private banking models. By the late 1990s the foreign banks had again found the going tough and had all either changed their models or scaled back their private banking operations.

The international players had discovered, yet again, that Australians have long relationships with their bank, their accountant and their stockbroker. “The European style model, based on integrating the functions of banker, accountant and stockbroker doesn’t work in Australia. There are a lot of millionaires, but there are not enough people who are wealthy enough to justify the high costs and overheads associated with an integrated private banking model," said Bates.

Size of the HNW market

Information on wealth is not readily available and such valuable knowledge is invariably produced by the sophisticated research engine rooms in the major private banks and jealously guarded within the inner sanctums of these organisations. Simon Kelly, of the University of Canberra’s National Centre for Social and Economic Modelling, reported in his 2001 report “Trends in Australian Wealth – New Estimates for the 1990s” that by June 1998 the wealthiest one per cent of Australian ‘income units’ had on average each amassed an average wealth of A$2.24m. A simple extrapolation of Kelly’s findings indicates that in 1998 Australia’s wealthiest one per cent held A$110bn in investable assets (excluding the family home and other illiquid assets such as rental properties, business investment and superannuation).

Macquarie Private Bank requires new clients to hold more than A$4m in investable assets as an immediately achievable goal. Guy Hedley, head of private banking at Macquarie Bank, was prepared to disclose only that Macquarie’s research indicated that the number of HNWs in Australia above this threshold was “in the thousands”. Hedley estimated that Citibank, presently shifting its focus from HNWs with investable assets of at least A$10m to a new wealth threshold of A$50m, was competing for a pool of the top 150 HNW family groups.

UBS' Morgan reported that total investable wealth in Australia (excluding the family home) is in the order of A$1.2trn. He told Private Client Management that the 250,000 individuals owning more than A$500,000 control A$350bn of wealth. There are about 2000 people in the ultra HNW sector (those with investable assets more than A$10m) in Australia. He estimates this group is growing at about 15 per cent per year.

Australian wealth is concentrated particularly in the population centres of Sydney and Melbourne. A growing mining wealth is also emerging in Perth. Queensland, with its tropical climate and attractive lifestyle, is becoming increasingly popular as a lifestyle choice for HNWs, particularly on the Gold Coast rather than Brisbane.

HNW strata

Private bankers in Australia tend to stratify their client base, offering different services to each stratum. Tom Murphy, head of investment research, Deutsche Private Banking, declined to put a number on the top one per cent of households in Australia with which Deutsche deals, but said within that parameter it identifies three distinct sub-groups of investor - inherited family wealth, entrepreneurs and executives. Deutsche has a well-articulated strategy for each group although Murphy declined to give further details.

UBS focuses on the mass affluent market by setting specific acceptance criteria for target groups at three different levels, based on the amount of investable assets held by potential clients. It then tailors its services according to its understanding of the needs and capabilities across these strata. Potential investors holding at least A$1m are its primary target group. The secondary group holds at least A$500,000, which UBS believes can benefit from its services. Potential clients at its third target level stratum must hold at least A$300,000. At this minimum level, the investor must be able to demonstrate the capacity to grow, as in the case of an executive investor, before UBS considers that the investor can benefit from what it has to offer.

He indicated that HNW investors are looking for both wealth management and wealth creation services from UBS, and all investors expect investment performance. UBS offers its clients in its third and second strata groups that are those with assets up to A$1m, a standard offering, which includes asset allocation, advice and access to domestic and offshore equity. Its primary group, those with more than A$1m, expect more tailored solutions, including structured products and access to unusual markets, in addition to everything that is offered to the lower tier. UBS defines its ultra HNW clients as those with more than A$6m of investable wealth. These investors expect diverse asset allocation choice, including unique opportunities, private equity, mezzanine funds, hedge funds, consolidated structured products, in addition to all of the company’s other offerings, Morgan noted. "It’s about creating specialist solutions to solve the specialist needs and problems of ultra high net-worths."

Competition

Macquarie considers that it has no national competitors in its market beyond Citigroup, each focusing on ultra HNWs. “UBS concentrates on the mass affluent and Deutsche has just halved its team in Australia, which doesn’t suggest increasing its presence,” Hedley observed. Citigroup has taken a strategic decision to focus on the very high end of the market, increasing its client threshold from A$10m to A$50m, he added.

Morgan declined to indicate how many ultra HNW clients UBS services other than to note that this has been a high priority target segment for the firm and that it is satisfied thus far. Bates considers that there is little room for new players in the Australian private banking market due to its rapid growth. “Many have been waiting on the sidelines for an opportunity to jump in, but it hasn’t happened,” he said.

Australian HNW market

Stephen Robertson, head of retail at Citigroup Asset Management, observed that HNWs are now demanding tailored services in relation to their wealth management strategy. “They buy a bespoke suit from the tailor, have their house architecturally designed and buy a sports version of a BMW. HNWs are used to getting tailored services.”

Morgan described the distinguishing characteristics of Australian HNWs. “High net worth individuals, particularly at the ultra high end, tend to have made their money themselves. In Australia they don’t tend to have the sort of accumulation of family wealth over generations as in Europe…Here, HNWs are closer to the creation of the wealth and want to be involved in its management.” UBS has responded by offering a hybrid service that emphasises keeping clients involved in decision-making.

Bates holds a similar view. He recently chaired a conference in Asia where Asian private banks were describing their clients in the same way. “The wealthy tend to be busy, active people, who have made their money in their own lifetime and therefore want to retain control of what’s happening with their money, and have a good understanding of financial markets.”

The main feature shaping the HNW market now, according to David Prothero, head of investment wealth management at PricewaterhouseCoopers, is the existence of wealth trapped in two main areas: property or an operating business. The trick for HNWs is to unlock that wealth and stream it into an area that is independent from that business. “The market is therefore seeing a great deal of venture capital, IPOs and small cap funds, because HNWs need vehicles that the capital markets can provide to unlock that wealth.”

Prothero believes that the European model of wealth management fails to recognise that HNWs in the Australian market have grown up with the philosophy of diversifying their investment service providers in order to maintain a level of privacy in relation to their affairs. By giving individual service providers a look at only a portion of their assets, the investor conceals their true asset position from all players.

This is why HNWs prefer to retain multiple wealth management service providers, Prothero says. The European model in contrast has ingrained in it a very long history of privacy, in the classic Swiss banker tradition. Therefore, European investors have not had the same incentive for segregating their service providers. UBS is committed to integrated reporting and believes that HNWs want to source banking, stockbroking and accountancy services from the one provider to take advantage of that service.

Ultra HNWs typically have an independent team of advisers who may contract out certain functions to firms such as Macquarie, according to Hedley. Macquarie therefore has a secondary relationship with its ultra HNW clients. This group are looking for wealth management not wealth creation, as well as solutions to generational and succession issues. Macquarie develops an individual asset allocation strategy, implements it and monitors its performance, using a ‘best of breed’ product approach. Most wealth managers indicated to Private Client Management that they also adopt a best of breed strategy, allowing them to shop around for the most suitable asset allocation mix, even if that involves buying a product from a competitor.

Hedley distinguished the investment strategies of the ‘big four’ trading banks with those adopted by investment banks. “The trading banks focus on the liability side of the balance sheet and structure an investment proposal off the back of that. An investment bank approaches the advice from an investment focus first, and then revisits the liability side. It’s a more sophisticated approach.”

Bates, who acted as a consultant to the banking industry during 2000, including direct consultancy work with Commonwealth Bank, St George Bank and Deloitte Private Banking, contrasted the wealth management strategies of the ‘big four’ trading banks: “Commonwealth Bank provides banking services, and a whole lot of product, but no financial planning. Westpac provides some financial planning services, while National Australia Bank has the most integrated approach to its private banking area - the financial planner sits next to the estate planner, the tax person and the banker.

ANZ has changed its wealth management strategy many times, ultimately outsourcing the investment management side of its business.” Private Client Management sought interviews with CBA, Westpac, NAB, ANZ and St George Bank for this article. ANZ declined and the rest did not return calls.

Deutsche uses a mean variance optimisation investment strategy for its clients, which essentially means that the bank must make assumptions about the volatility and characteristics of each sub-investment class. “Typical asset classes used by Deutsche for its HNW clients include absolute return strategy (or hedge funds), private equity, private equity in more than one geographic region, and infrastructure,” said Murphy.

Hedley believes that Australian HNWs are more focused on property as a principal means of wealth management than their European and US counterparts. This is in part a legacy issue, and in part due to capital gains tax advantages property investment still enjoys. “Beyond these financial drivers, there is an ingrained philosophy of residential property investment, particularly with the mass affluent.”

Tax is an important factor in HNW investment decisions but not a dominant driver in asset allocation, noted Morgan. Hedley, similarly, said that clients must take steps to ensure they do not lose with tax, but it is not the primary driver. Australia’s marginal tax rate is relatively high, at 48 per cent, and with that it becomes economic to create tax structures that can be maintained in order to legitimately minimise tax.

Trust structures and private company structures were typical techniques used by HNWs to achieve this, he said. Any technique or set of techniques adopted carries with it a whole set of compliance issues, Prothero pointed out. “Accounts must be prepared and maintained, assets and income must be separately reported, and tax returns must be prepared separately for different vehicles. They are complex structures,” he observed.

Murphy identified the Foreign Investment Funds and Life Assurance Policies Regulations, known as the FIF regime, as a critical tax issue for HNWs. The FIF regime requires investors to report unrealised capital gains in portfolios held overseas. “Private equity products typically require reporting under FIF. The tax regime is considerably more sophisticated in this country than it is in most other countries in the region." Deutsche, like other investment banks, includes filters in its legal and compliance frameworks to identify these reporting issues for clients.

The Australian Taxation Office set up a comprehensive compliance programme in May 1996 to expand its understanding of the tax planning techniques used by HNWs and the resulting compliance risks. Over a four-year period, the ATO examined more than 400 HNWs, and it built a profile of each HNW's business structure and tax strategies to identify common tax planning practices. Some were required to lodge more detailed information in their annual returns. The ATO estimates that its compliance programme has resulted in additional revenue collection of almost A$200m.

Offshore investment is an increasing trend in the Australian market, but its occurrence is still relatively low when compared to the value of the Australian share market, according to Hedley. The difficulty for HNWs wishing to monitor offshore investments is the capability to deliver service at the other end.

Deutsche has found that many HNW clients want offshore exposure, particularly if they ‘think’ in an offshore currency. “The first question I ask a client in the risk profiling process is: ‘How do you measure your wealth, what currency do you think in?’” said Murphy. Many of Deutsche’s clients seek investment in European equities because of the exposure it gives them to 12 countries under one currency, together with the trade barriers which have come down to support that, Murphy said.

Many of Macquarie’s clients use hedge funds because Macquarie has very high skills as a group in exotic or structured products, according to Hedley. “Hedge funds are a growing area, and there is a movement down to less sophisticated investors in terms of accessibility for these products.”

Fee structures

Macquarie’s basic service strategy is advice and it charges on a purely advisory basis. Hedley argued that for private banking to survive in Australia, it must attract the best advisers in the market. The fee basis for private bankers relative to stockbrokers and financial planners has not encouraged that. Deutsche’s fees are based on funds under management and are not product based. Advisers receive salary and bonus only. “Clients don’t want to see compensation based on commission or rebates,” Deutsche's Murphy said.

UBS offers its clients fee option combinations, depending on the level of advice given, Morgan said. “Fees now have much less relationship to the transactional side and there is more emphasis on the advisory side, because that’s the service HNWs want.”

Prothero observes that HNWs are typically people who are self-made. He believes that these HNWs look at the fees they are paying and struggle to understand their relationship to the value being added to their wealth under management. Prothero says that a demand for transparency in fee structures that demonstrate value for money is emerging in the market. “In response to this demand, fee structures will drift, even race, to an hourly based approach rather than based on funds under management.”

Compliance issues

The commencement on 11 March this year of the provisions of the Financial Services Reform Act are having a quantum effect on the financial services industry in Australia at all levels, not least in private banking. The key provision for advisers is policy statement 146, which deals with licensing and the training of financial advisers. Essentially, advisers must be properly qualified and junior staff must be properly supervised in their contact with customers. PwC has been heavily involved in advising clients in relation to the FSRA and sees the legislation as a positive development in terms of customer protection, according to Prothero. He observed that most firms are in a position where they must take some action to comply. For the bigger firms this may be simply moulding or modifying what they are presently doing. Hedley cited the PS146 regulations as a source of further significant compliance costs to business, but said: “If a business takes the view that it’s a nuisance, it will be.”

Morgan observed that as the industry becomes more driven by regulation many products for HNWs require an adviser who is highly qualified. He gave the example of optional derivatives strategies, for which an adviser requires options level two qualifications. “A true client adviser these days needs to be, if not an expert, at least well briefed in all compliance areas. These areas of knowledge must include superannuation, trusts and accounting practice and strategies.”

New Zealand

For some firms, such as UBS and Citigroup, the New Zealand market is too small in the context of a regional strategy to justify a presence. For others, New Zealand represents a significant opportunity to service the growing numbers of wealthy locals and mainly Australian ex-patriots there.

Macquarie runs a full advisory operation in New Zealand. “It’s an important market and represents a great opportunity. New Zealand is attractive for a lot of HNWs for a lifestyle destination. Therefore wealth is being created in a foreign market and being invested in New Zealand," said Hedley. Queenstown, and the South Island generally, are the main wealth zones for migratory HNWs, while local HNWs are still based in Auckland and Wellington.

New Zealand exhibits some significant differences from the Australian market. “There is not the same focus on tax and superannuation. There is no compulsory superannuation, unlike Australia, and it has a less complex personal tax regime. Wealth management is not as well organised in New Zealand,” said Hedley.

Hedley indicated that, while it is a relatively small market, the principles are similar to Australia. “There is a high focus on property, but given the smallness of the market, there is a greater willingness to invest internationally than there is in the Australian HNW market.” Hedley worked in New Zealand with JB Were, where typically clients held more than half of their investment portfolio outside the New Zealand investment market, with Australia being the second largest focus. Macquarie and Were are the two dominant HNW players. Deutsche has one official locally who works very closely with the private bank in Australia and the Asian region.

Boutique advisers

A relatively small but increasingly significant group of asset managers has established a firm foothold in the HNW asset management market in Australia. Members of this group of ‘private’ or ‘boutique’ investors include Caledonia Investments, Carnbrea & Co, MF Custodians and JM Capital Management, and between them appear to have gained a loyal following at the ultra high end of the market.

These publicity-shy investment advisers typically neither advertise nor use intermediaries and adopt a radically different wealth management model from the traditional players. An official at Caledonia, which has been operating for ten years, told Private Client Management that the firm accepts only investors with investable assets of more than A$10m for its managed accounts, although it will accept investors with A$1m for its pooled fund. He suggested Caledonia was almost alone at the ultra HNW end of the market, and that most ultra HNWs in Melbourne and Sydney would have some association with Caledonia. Each HNW would typically use a number of other advisers and take care of many of their investments themselves, investing a slice of their total investable assets in the care of Caledonia. It invests money for clients in the Australian equity market only.

Ultra HNWs like Caledonia because it makes investment decisions based on common sense that HNWs understand. They do not use sophisticated performance measurement techniques, such as indexes and tracking error.

Most of the major investment banks, including Macquarie and UBS, report that their clients seek a ‘measured out-performance’ in investment return. HNWs are seeking wealth maintenance and wealth creation and are often promised both. The source suggested that relative performance is no comfort to an individual, so Caledonia uses absolute results in measuring performance. Investec Australia is also active locally and accepts investors with A$2m in investable assets for strategic asset allocation advice and relies on its reputation in the market and cross referrals for business, said Michael Sack, director in Melbourne.

Sack sees top end HNW wealth management as an important future market. "Much of the wealth, which has been produced through trading, manufacturing and other entrepreneurial activity, is now being passed to the next generation. The core business has been sold. Therefore there is a need for top end financial advice."

The future?

“The people who own relationships in Australia - the bankers, stockbrokers and accounting firms - are all moving into this thing called ‘wealth management’,” Tony Bates observed.

David Prothero believes that the preference of HNWs for multiple service providers will break down, as the market becomes increasingly complex. “HNWs need people with a very high understanding of their position and assets in order to put something together that makes sense.” Prothero predicted an accountant would probably own this relationship because it is the accountant that has both ultimate compliance responsibility and the technical accountancy skills required by the complex market.

Prothero believes that either explicit relationships will emerge between banks and accountants or that some sort of line in the sand will be drawn between both groups to determine how HNWs will be serviced. The tension that will continue is the reluctance of HNWs to bare their financial souls to a single wealth adviser. “If this is the case, segregated servicing of HNWs will endure."

Attempts by the accounting profession to diversify into financial planning have met with mixed results. Prothero reflected on the recent ASX listings of Stockford and Harts Australasia. Both are struggling to achieve their goals in their new fields. Harts was recently placed into liquidation. Accountants must first resolve two issues: the lack of skills they have in integrated financial services and their independence and conflict issues. “If they don’t, accountancy firms will ultimately say someone else has to do that because we don’t travel in that area.”

It seems certain that ultra high net wealth will continue to grow. Kelly found that the number of millionaires in Australia is doubling every four years. The top percentile of family groups in Australia will hold investable assets well upwards of A$1.58bn as high net worth individuals move to retirement.

The high-end boutique asset managers are well placed to gain market share from traditional market players in this future scenario. Or will forces from within the accounting field find a way for the profession to combine its traditional supporting role with a more proactive wealth management function? Perhaps another model will emerge.