LONDON, Oct 18 (Reuters Breakingviews) – Wealth management was a rare bright spot for banks in the otherwise uninspiring decade and a half that followed the last financial crisis. Between 2008 and 2022, the net assets owned by households worldwide more than doubled to $454 trillion, according to research by UBS – one of the major lenders that decided to focus on the business of looking after well-heeled clients’ fortunes.
Yet the period of low-interest rates and central bank money printing, which inflated the value of financial assets, has now flipped on its head. For wealth managers, that will make revenue growth much harder to come by, shifting the focus to controlling expenses. The silver lining for big players is that minnows will struggle the most.
LOSING ITS SPARKLE
In Wall Street parlance, wealth management is a capital-light business. Because private banks mainly oversee assets owned by clients, they require less equity funding. That made the industry particularly attractive after the post-2008 regulatory crackdown when higher capital requirements squeezed the profitability of many banking activities. Morgan Stanley’s (MS.N) wealth unit averaged a 32% return on tangible equity between 2017 and 2022; the Wall Street firm’s trading and investment banking unit managed just 13%.
Little wonder Morgan Stanley boss James Gorman focused on wealth management after taking charge in 2010. So did UBS (UBSG.S) Chief Executive Sergio Ermotti, who recently returned to the helm of the Swiss bank following its rescue of rival Credit Suisse. More recently, firms ranging from Goldman Sachs (GS.N) to HSBC(HSBA.L), (0005.HK), Britain’s Lloyds Banking Group(LLOY.L) and Italy’s Mediobanca (MDBI.MI) have put wealth at the heart of their strategies.
However, it’s hard to see the industry growing as fast as in the recent past. Start with management fees, which account for more than half of revenue in Morgan Stanley and UBS’s wealth divisions. These are usually charged as a percentage of the client’s investment portfolios, which means the bank’s income fluctuates with the market value of stocks and bonds.
That was helpful when rates were low and asset prices rising. Between 2015 and 2021, for example, Morgan Stanley’s fee-based client assets under management increased by 13% a year on average. About two-fifths of the growth, on average, came from movements in the value of clients’ portfolios. It’s hard to see that trend persisting with less buoyant asset prices.
Wealth managers also face shrinking fee rates. Revenue as a percentage of average fee-earning assets has dropped at both UBS and Morgan Stanley in recent years. The main reason, according to industry insiders, is that these banks are more aggressively pursuing ultra-high-net-worth clients. These individuals, who typically have fortunes of $30 million or more, can drive a harder bargain on fees. They also often have their own family investment offices, which means they don’t necessarily need a full suite of private bank services. The upshot is that each dollar of extra assets delivers a smaller amount of additional revenue.
Finally, high rates and volatile markets have dented wealthy investors’ appetite for risk. When the yield on government bonds and other cash-like assets was effectively zero, clients relied on wealth managers to find extra returns. Now that 1-year U.S. Treasury bonds yield 5%, the bar for taking extra risk is higher. If clients park more of their wealth in short-term fixed-income securities, wealth managers’ incomes will fall. At Morgan Stanley, $1 billion held in an account dedicated to cash-like assets on average earns the bank about $600,000 a year in fees. The same amount invested at the discretion of a portfolio manager would bring in $9.1 million, using average fee rates from the first half of 2023.
So far, shareholders are shrugging off these concerns. Giant wealth managers trade at a hefty premium to their closest regional rivals, suggesting investors place a higher value on earnings from the business. Morgan Stanley, which reported third-quarter earnings on Wednesday, is valued at 1.9 times the tangible book value analysts reckon it will have in 12 months’ time – a period during which the firm is expected to earn a 16% return on that equity. By contrast, Goldman Sachs, which is forecast to earn a 10% return over the same period, using LSEG data, trades at 1 times the expected tangible book value.
The challenge for wealth management executives like Iqbal Khan at UBS and Morgan Stanley’s Andy Saperstein is to live up to those high expectations. For example, they can steer clients into higher-margin alternative investments like private equity and debt funds. However, slower growth may also force them to look at costs.
Slashing expenses has proved tricky for wealth managers – particularly in the United States, where financial advisers have a closer individual relationship with their clients and therefore tend to pocket a large chunk of the fees. Expenses ate up over 80% of revenue last year in UBS’s Americas wealth unit, compared with 55% in Switzerland.
Even outside the United States, however, fierce competition between banks for well-connected advisers makes it tricky to reduce compensation. Meanwhile, anti-money-laundering rules and other compliance requirements keep pushing up back-office expenses. Clients, particularly younger ones, also demand increasingly slick digital tools.
The good news for UBS and Morgan Stanley is that they are better placed than most to handle these pressures. Size enables them to spread technology budgets over a bigger pool of assets. Big players also often get better access to sought-after investment products, like a new Blackstone (BX.N) real-estate fund.
Paired with slower growth, these economies of scale point towards further consolidation among wealth managers. Even after years of acquisitions and aggressive recruiting, the big players represent a tiny fraction of the market. After absorbing Credit Suisse, UBS looks after about $4 trillion in wealth assets: less than 1% of the bank’s estimate of global household net worth.
While UBS has enough on its plate for now, it makes sense for Morgan Stanley and other American giants to keep absorbing smaller financial advisory shops. Elsewhere there may be bigger deals on the cards: the value of Britain’s St. James’s Place (SJP.L) has slumped by around 40% to $4.5 billion since the UK regulator unveiled new fee rules in the summer.
Some wealth managers will doubtless find ways to evolve and grow. But the industry may find its heyday is in the past.
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