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Sunday, June 26, 2011

Private Banking - Evolve or Dissolve

Private banking needs to evolve if it is to survive.  

In this article we are going to look at the changing market dynamics and the challenges for private banking in Asia.  Private banking has experienced huge growth across both the domestic and expatriate community but it has reached a tipping point where change is imminent. If private banking is to continue to prosper over the coming years ahead, it is going to need to take advantage of these trend shifts rather than push against them.

There are two recommended and outstanding presentation links at the end of this blog which are worth reviewing.

Private Bankers today
"When I was young, people called me a gambler.  As the scale of my operations increased I became known as a speculator.  Now I am called a banker. But I have been doing the same thing all the time" | Sir Ernest Cassell, Banker to Edward VII.

Private Bankers of the past were just that, expert sources of not just market knowledge but also insightful personal advisors who actually looked after their clients wealth, they were the conduit between the buy side and the sell side.  Today however, gosh has this dynamic changed. Private bankers of today have become in much of the part glorified promoters of mutual fund products, they are little different to mobile phone sales people on a street stall and they are often flogging inappropriate instruments created for the masses.  It also kind of feels that some of the institutional investments offered to clients seem to serve the banks more than the customers they are supposedly designed for.

The reintroduction of the specialist agent and a reversion back to the traditional banker is going to be one of the differentiating factors for the private banking sector. This is especially going to be the case when the sector consolidates and it will consolidate in the coming years ahead.

Growth and Changes in Private Banking
The credit crisis did have some noticeable and expected impacts to the private banking space, mostly around the market shock phases of the crisis. There were redemptions of course but unexpectedly, the private banking sector was quick to capitalize on bounce back opportunities and maintained a relatively stable profit margin.  All this aside, the market appears to be changing partly as an outcome of the credit crisis and this is because it has driven a geographical shift or re-concentration of high net worth individuals across the globe.

Figure 1 : The size of the HNWI Wealth Forecast by Booze & Co

More information on the Booze presentation can be found by following this link - After the perfect storm.

Some of the key noticeable changes include the following:

[1] Switching the asset classes
One of the most obvious changes was the loss of interest in a portfolio heavily focused on equities with risky investments targeting buy side securitization products such as mortgage backed securities. A switch from these asset classes onto bonds and commodities is the new fad as investors attempt to stabilize their returns.  The equities market will always attract the private investor however there is an increasing appetite for fixed income instruments and private bankers which are up to speed selling these asset classes will do better maintaining a high closing ratio and longer tenors of participation from their clients.

[2] Strengthening of the Asia channel
Asia in many respects skirted the Global Financial Crisis and since the recovery period of mid 2009 the region has been experiencing incredible GDP growth. Interestingly, most noticeable market strength has been found in the developing countries of the emerging markets rather than the developed.

Figure 2 : GDP Growth Globally

This trend is like to continue over the next five years as the west pushes on deleveraging and struggles with broader economic recovery issues which are more likely to be fits and starts with a few set backs on the way - Nothing is a straight line to the top or the bottom as it may be.   It is possible that high levels of debt found in Spain, Ireland, Greece as well as the US itself, could spark a W-shaped recovery but either way; Asia is the hot topic and it is probably going to remain that way for the next five years.

[3A move to self-manage
If the credit crisis taught the private investor anything, it was that a managed fund may not have been that well managed. The emergence of Client-to-Market electronic channels such as those that are provided by Saxo Bank or Interactive Brokers were gathering momentum anyway however many investors that were not properly informed by account managers during the crisis are now looking to these platforms as a way to access the markets. In effect they bypass the private banker in the process and unless the private banker is able to provide sound investment advice or differentiated products, their value add is going to be pretty small.

The emergence of exchanged traded funds which are more commonly referred to as ETF's that follow entire indexes are giving these day traders an easy way to entertain quite sophisticated trading strategies such as shorting. ETF's also allow investors to track and speculate on indexes where returns are already market efficient from sector perspective and this can all happen without the trader having to do very much work, if any at all.

These factors have lifted the knowledge gap that your average investor has. Investors are savvy and it is possible they know more about the markets than the average private banker out there. Private banking standards have to improve if they are to service the industry properly, we have to move away from a market full of over paid mobile phone salesmen and back to an industry that commands respect.

[4New Period of over regulation
The regulator landscape has strengthened over the last twenty four months in many ways which has also had knock on effects to the private banking sector.  Firstly there has been a wave of tax evasion hunting going on as governments around the world attempt to reign in all available cash that is due to them.  This started with the US government demanding tax havens improve regulatory oversight in an effort to ensure that member banks operating in these jurisdictions disclose account details and holdings.  Secondly, many new mandates have been introduced such as the Frank Dodd Act. These rulings are not only changing the way investments are sold but how ratings are used to grade securities.  A Strengthening of the financial sector is expected to continue and hedge funds are now coming under the watchful eye of regulators.  All of this makes for challenging times ahead for private bankers who will need to be cautious in how they sell investments. They must sell within the new guidelines and accept the guidelines are in a flux of change.

[5Goodbye Lock-ins and Watermark Headaches
Investors are becoming wary of long lock-in periods especially during illiquid market conditions. In the past these predicaments were generally accepted although, begrudgingly by investors however, investors are now starting to review lock-ins as part of their placement criteria when they select an investment program.  Those schemes with long lock-in periods are becoming increasingly unpopular.

High-water marks ensures investment managers are not paid for poor performance by setting a standard where and how they charge fees.  If the fund looses money over a period of time the fund manager will need to bring returns back to the announced high-water mark before they receive their bonus.  Going out in the midterm, volatile markets are going to test the high-water concept and investment managers stand to carry potential bonus trims if they under perform.  While this mostly impacts hedge fund managers, there are other funds out there which may be impacted by high-water marks.

[6Changing Demographics and Segmentation
Demographics and market segmentation have become increasingly important. As India and China move deeper into positions of global economic power, an entire middle to upper class of local market citizens are looking for investments both within their own market but also cross-boarder. In some cases, this local market investment pool is replacing the dampened volume in developed markets. In line with this trend, some of the largest buyers of exclusive property in western cities such as London or Paris are being taken up by foreigners from the emerging markets. This presents several opportunities for fund managers that are operating real estate investment trusts tied around such investments or firms with a global reach.

From a segmentation perspective, private bankers will need to have a rich portfolio of options to capture this wider market and they can achieve this by offering an array of assets that appeal to the differing needs of this diversifying global investment class. Private bankers need to consider moving away from flogging mutual fund plans off the shelf if they are to capture this market.  If there is one thing to take away from this article, it is; the standardized mutual fund pension plan sold in a box is on the way out unless it has really good online reporting and investors can switch between funds within the investment program rapidly and electronically.  I only know of a couple of mutual fund facilities that meet this criteria.

[7Continued Growth of the offshore book
Quantitative easing, austerity measures and high interest rate spreads between differing trading zones has made Asia look attractive to the west, it has also strengthened Asian currencies improving the value of assets in developed countries for buyers in the east. Both these effects are encouraging offshore carry trades between jurisdictions and private bankers who are able to connect the buy side with the sell side and cross-boarder, can run a very lucrative book.

As to be expected, most of the opportunities that we have discussed here cannot be found in a standardized pension fund and investors are increasingly becoming aware of this. Private bankers that are able to offer these type of diversified investments are going to do well at capturing market interest. So what I hear you say, well as investor sophistication develops over the next five years, if the private banker is not offering attractive products, they will see attrition of customers on their books.    
Part II
I am considering writing a part II of this article where we will continue on in the theme of the private banker and look at some of the new opportunities specialist can exploit to better service the market. Perhaps we'll highlight the key features found in a good investment program and point out which funds to avoid and why, it could be a fun name and shame game. In the meantime however, you can find the link to the presentations mentioned in this article below this blog. They follow the theme of this blog closely however my opinion above is just that and, very far from a mirror of these articles.

PWC Presentation Link : A worthy article to read is the PWC Anticipating a new age in wealth management.

Booz & Co Presentation Link After the perfect storm.

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