The wealth-management sector is grappling with a variety of challenges that are contributing to lower revenue and higher costs, and the resulting profit squeeze is forcing financial services firms – and financial advisors – to expand and diversify their offerings more than ever before.
Although the global wealth-management sector has seen total assets under management increase since 2008, the costs associated with managing those assets have risen faster than the growth in the income that managing those assets produce, according to the 2012 World Wealth Report, recently released jointly by global consulting firm Capgemini and Royal Bank of Canada‘s wealth-management division. Executives at Canadian wealth-management firms can identify with this trend.
“I think the [sector] as a whole is seeing a revenue challenge,” says Andrew Marsh, CEO of Toronto-based Richardson GMP Ltd.
Primarily contributing to slower revenue growth is the shift in client preferences. Since the financial crisis – and during the extended period of market volatility that has followed – clients have been flocking in record numbers to safer investments such as bonds and guaranteed investment certificates. Clients are spooked by the extreme market swings and many clients also are approaching the age of retirement, prompting them to focus on capital preservation.
“Clients are no longer allocating a lot of their portfolios to the higher-fee or high commission-earning assets,” says David Wilson, group manager of market intelligence and strategic analysis in Capgemini’s financial services global business unit in Hyderabad, India. “They’re staying in things that are fairly liquid and safe.”
This has had a noticeable impact on revenue at wealth-management firms, Marsh says: “The product mix to support an asset allocation that has much more fixed-income and money market [investments] and some of the yield instruments is a much lower-margin business.”
Simultaneously, these firms are struggling with steadily rising costs. In particular, advisor compensation costs have been climbing as firms compete for experienced, top-producing reps.
“Now that we’ve seen a prolonged period of market and portfolio turmoil,” says Wilson, “I think clients really put a high premium on experienced advisors who have that intangible experience of having ridden out one or two market storms. You pay a premium to bring experienced advisors or advisor teams into your organization.”
Indeed, Marsh says, the market for successful advisors in Canada has gotten increasingly competitive: “The best advisors are in as great a demand as they’ve ever been. The ability to retain and recruit top talent is difficult today and, therefore, more expensive.”
Compliance costs also have been climbing as regulators around the world have imposed rules aiming to reduce systemic risk and protect investors in the aftermath of the financial crisis.
“As we get into an environment in which there are more demands from regulators, every firm has to rise to that and be able to meet that,” says Mike Scott, managing director of RBC Dominion Securities Inc. (DS) in Toronto. “And all those things cost money.”
With plenty of new regulations in the pipeline, wealth-management firms fear that their cost burden will worsen.
“We are certainly concerned about it, looking out the next five to 10 years,” says Marsh. In particular, Marsh is anticipating that the current regulatory push for enhanced disclosure will require firms to make substantial and expensive changes to their existing systems. “As the regulators focus more and more on how we report to clients and what we disclose to clients and improving transparency, I’m concerned that that will require a complete reinvestment in the infrastructure and systems.”
Scale is key to managing costs, the joint report suggests. It urges wealth-management firms to focus on growing their business and expanding their offerings in order to foster revenue growth and keep costs in check.
DS’s scale has certainly helped that firm manage costs, Scott says: “Our costs have gone up. But when you look at the overall size of our business, it doesn’t really affect us. Smaller firms [however,] are in a very tough situation.”
The report notes that rising costs probably present the greatest hurdle for smaller players.
However, says Marsh, there are also advantages to being small in size: Richardson GMP has a relatively small network of advisors, so the firm’s infrastructure costs are much more manageable compared with those of larger firms: “We have fewer bodies in fewer locations and, therefore, the head office cost structure to support that infrastructure can be very lean. And, therefore, more cash flows hit the bottom line.”
More important than achieving physical scale, the report says, is achieving scale that provides new sources of revenue growth – for example, offering clients a broader range of products and services.
“Scalability is not about absolute size, but about the ability to generate returns at a lower incremental cost,” the report says. “This type of scalability is likely to be the earmark of ‘next-generation’ business models, because it better positions firms to navigate the changing landscape profitably.”
Many wealth-management firms have recognized the advantages of expanding the scope of their products and services. Scott says DS always has offered a comprehensive set of wealth-management services, which has helped limit the extent to which the firm’s revenue growth has declined in recent years: “Our revenue is not down that much. Part of the reason for that is, as well as making sure we’re very focused on investment management, we’re bringing other solutions to clients, such as wealth management, and there are revenue sources that come with that.”
The financial services industry’s shift from investment management and toward holistic wealth management has been underway for several years now, Marsh says. He notes that along with firms, individual advisors could benefit from embracing this type of business model to generate a more consistent stream of revenue.
“Those advisors that are still selling products as their value-add to their clients will struggle,” Marsh says. “Those advisors who have evolved to be much more focused on the process of wealth management – that holistic and total wealth view and approach – achieve a higher professional standard, but also achieve more of a fee-based recurring revenue model that’s less subject to the whims of economic and financial markets.”
© 2012 Investment Executive. All rights reserved.