Related Expertise: Financial Institutions, Wealth Management, Marketing and Sales
For 14 years, BCG has conducted a proprietary benchmarking survey of wealth management providers from all over the world, running the spectrum from small boutiques to the world’s largest wealth managers—and covering multiple business models, from onshore to offshore and from banking to brokerage. A key finding in this year’s benchmarking is that average revenue and profit margins declined for wealth managers from 2012 to 2015. (See Exhibit 1.)
This development underlines the need for new strategies and approaches. Three major trends have altered—and will continue to alter—the face of wealth management: tightening regulation, accelerating digital innovation, and shifting needs in traditional wealth-based client segments.
Regulators worldwide remain determined to increase transparency in the products, prices, and processes of wealth managers. Their overall goal is to eliminate conflicts of interest, help investors understand increasingly complex financial products, and ultimately strengthen investor protection. For example, more and more countries are prohibiting inducement fees, through such means as the Markets in Financial Instruments Directive II (MiFID II) in Europe, the Retail Distribution Review (RDR) in the U.K., the Future of Financial Advice (FOFA) in Australia, and the U.S. Department of Labor’s so-called fiduciary rule. This last rule, which will take full effect over the next 12 to 18 months, requires financial advisors handling retirement accounts to put the best interests of their clients above their own profit goals. It remains to be seen whether the commission-based models of many broker-dealers in the U.S. market can coexist with this new fiduciary-duty rule.
Such regulatory steps will have a significant impact on wealth managers’ revenue potential in several ways: by putting pressure on fees and charges (through increased transparency); by limiting the products that can be offered on an execution-only basis without advice and proof of suitability (or of acting in the client’s best interest); and by restricting (or eliminating) inducement payments as a source of revenue. In 2015, our global wealth-manager survey respondents in regions where regulation is not yet in place derived 21% of their revenues from inducement fees and commissions (down from 24% in 2014), indicating a high level of dependence. In regions where regulation is about to be implemented, the share has already decreased to an average of 9%.
In addition to reducing revenues, regulatory measures will also increase costs for wealth managers as new systems, processes, and controls are put in place to ensure compliance, and as liability risk increases—with potentially severe financial penalties and reputational damage resulting from noncompliance. For our survey participants, legal and compliance costs have increased to 4% of total operating expenses, double the 2% average in 2012. According to Expand Research, a subsidiary of BCG, regulatory spending can represent up to 13% of IT costs, especially for smaller regional players.
Moreover, operational complexity will rise, with advice to clients requiring documentation and proof of suitability (or of acting in the client’s best interest). Costs will also have to be fully disclosed and broken down into categories, with any inducement fees and other potential conflicts of interest revealed. Relationship manager roles will need to continuously adapt to new regimes.
Of course, the new environment has a positive side in that nimble, highly skilled wealth managers can turn the challenge into an opportunity by creating compelling advisory offerings—often leveraging investment specialists—targeted at self-directed clients who wish to participate in their own investment choices. Although the share of client assets under advisement (either centrally or through the RM) increased to 19% in 2015 among our survey respondents, there is still enormous potential in the 46% of self-directed client assets that currently receive no contractually defined advice. For banks, increasing the advisory share is lucrative and carries the potential to raise client satisfaction and loyalty. On average, an advisory mandate delivers returns on assets that are 22 basis points higher than pure execution models, according to our survey.
Of course, the chief opportunity lies in creating clearly defined levels of advisory service that the client is willing to pay for, systematically injecting the bank’s research capabilities into individualized investment recommendations, and providing compelling digital services. Overall, the bank’s sales pitch becomes the following: “We will help you to find the right investments, and you will be able to monitor them continuously and interactively.” Varying levels of advice should be available to all clients regardless of net worth, although standard underlying services and products should be streamlined, using robo-advisors and fixed-fee models for smaller clients and teams of experts for larger, more complex client portfolios. In 2015, 82% of our survey respondents still provided affluent clients with RM-centric service. Nonetheless, this model may not be economically viable once new regulations come fully into force—as evidenced in markets such as the U.K., where smaller clients are increasingly less likely to receive personalized financial advice.
By shifting toward diverse product packages—in particular by moving from execution-only to fee-based advisory services—wealth managers can potentially complement commissions with more predictable revenue streams. We are already observing a shift away from commissions to recurring fees. Among our survey respondents, fee-based revenues represented 43% of total revenues in 2015, compared with 38% in 2012. There is even greater potential in customizing pricing plans on the basis of clients’ product needs and activity levels—as well as on their overall value to the organization.
A successful, systematic advisory process should cover structured client-book planning (weekly and daily coverage) and implement sales targets with clear KPIs linked to incentives. A big element of developing such a process is rigorous RM training. Among our survey respondents, the average cost of training per RM in 2015 was roughly $1,000, a figure that will likely need to increase. Effective RM training can result in a front line that truly understands client goals and risk profiles and is able to deliver holistic advice that goes beyond short- and medium-term investments—which are close to becoming commoditized, partly because of regulatory restrictions—to include broader advice that encompasses lifestyle choices and long-term financial objectives.
With the rise of financial technology firms and the rapid evolution of smart analytics (or big data), digital technology is changing the rules of the wealth management industry. Most players are committed to making digital transformation a top priority. Fully 97% of our survey respondents said that they planned to invest in digital capabilities, and 64% believe that digital capabilities would be the key to serving the next generation of wealthy clients. Clients themselves have also voiced a need for digital engagement, indicating that it provides a noninvasive and efficient way for them to receive effective service. Nonetheless, many wealth managers are still trying to figure out how to derive value from their investments in digital capabilities.
Indeed, the time for action is ripe. We estimate that the number of asset- and wealth-management-focused financial technology companies has more than doubled, from roughly 315 (with funding of $1.7 billion) in 2012 to about 700 (with funding of $4.9 billion) in 2015. These companies are known primarily for low-cost, algorithm-based asset-allocating platforms (or robo-advisors), but they also offer digital advice, portfolio composition, and execution, as well as customized portfolio optimization and recommendations for high-net-worth (HNW) clients. They tend to specialize in certain steps of the value chain, particularly in finding the best investment solutions for clients and interacting with them. By contrast, most traditional wealth managers cover the entire value chain and struggle with digital capabilities.
Big data is also playing a key role in revolutionizing the industry. In the past, most wealth managers were limited to analytics for financial reporting and control. Today, big data has evolved to the point where enormous amounts of unstructured internal and external data can be processed within very short time periods, greatly enhancing the ability to predict clients’ product preferences, accurately gauge the regulatory compliance level of both clients and RMs, and prevent fraud, among other uses. Wealth managers that seamlessly inject analytics-based insight into client interactions will be able to increase their share of wallet through highly tailored services—taking a page from luxury-goods firms and other consumer-centric sectors and possibly changing the way investment solutions are identified and proposed.
In our view, wealth managers need an entirely new perspective on digital capabilities if they hope to tap the full potential and unlock multiple opportunities across their business models, particularly in the areas of revenue enhancement, cost optimization, and operational effectiveness.
Revenue Enhancement. Smart analytics allow for precise customer targeting through both descriptive and predictive analysis. For example, a trading-oriented client with a high risk tolerance will have markedly different research requirements, price sensitivities, and investment horizons than a client who delegates investment decisions. Wealth managers now have the opportunity to use behavioral, demographic, and lifestyle data to think ahead of the client in determining the next logical investment.
Providing clients with quality advice and products at the right time through the best channel—increasingly a digital channel—will dramatically improve the client experience, which will ultimately lead to increased client trust and loyalty and a higher level of activity and interaction. Many wealth managers still dramatically lag behind in providing the digital services that clients are accustomed to receiving from retail banks and consumer-goods companies. Current digital offerings are not compelling enough to engage the client, and are not built around the few key client journeys that truly make a difference. Ultimately, the combination of better digital engagement and smart analytics has the potential to lift revenues significantly.
Cost Optimization. Middle- and back-office costs accounted for 53% of total costs for our wealth-manager survey respondents. Investments in digital technology are a significant part of these costs. According to Expand Research, client and advisor technology now makes up 29% of total IT spending, on average, up from 23% in 2013 for a representative sample of wealth managers. This trend is driven primarily by the need to establish a sophisticated digital foundation and by the potential that wealth managers see in pursuing digital capabilities in the long run. Many IT organizations have focused on providing the front office with better self-directed tools in order to drive productivity and improve the client experience through a more effective digital platform.
From a long-term perspective, however, digital technology gives wealth managers the opportunity to serve affluent clients efficiently through a lower-cost, commoditized approach. Furthermore, wealth managers can leverage technology to reduce costs in portfolio management, research and product development, operations, risk compliance, and other support functions—while also leveraging sophisticated communication and advice tools that enhance the offering for HNW and ultra-high-net-worth (UHNW) individuals. Financial technology companies are leading the way with innovative ideas in this space.
Operational Effectiveness. A properly implemented digital initiative provides a huge opportunity to standardize and simplify processes, identify areas to insource and outsource, and work jointly with other players to create efficiency gains, especially in the middle and back offices. Wealth managers must therefore understand that digital technology is not just another silo next to their traditional business model but rather a change in their DNA, requiring systematic process redesign and integration with legacy elements. This realization can lay the foundation for focusing on the links in the value chain where wealth managers can truly differentiate themselves.
It is important to note that a comprehensive digital initiative cannot be based on incremental improvements, as has often been the case in the past, with multiyear projects driven by the IT department—nor can it be based on building a digital incubator lab that operates in an ivory tower with no connections to the day-to-day business. Focused prototypes must quickly be produced, tested, and improved, and innovations should be managed as a portfolio, not unlike a venture capital fund. Partnering with or even acquiring financial technology firms is an option for obtaining relevant capabilities at the speed required in today’s rapidly changing environment.
Of course, increasing digital interaction with clients poses its own set of threats in the form of cyber attacks and data leakage, and any incidents involving HNW and UHNW clients can potentially bring about reputational damage. Wealth managers must therefore ensure that proper infrastructure and security protocols are continuously upgraded to reflect the latest developments and threat patterns.
In order to be truly digitally transformed, wealth managers will need to redesign their entire business model and organization. The sales force must be brought on board, and great care must be taken to ensure that digital innovations and channels not only avoid putting pressure on margins but actually strengthen them. Only those players agile enough to keep up with the nimblest digital disruptors will prevail.
Upper-HNW households (with wealth of more than $20 million) and UHNW households (with wealth of more than $100 million) are the fastest-growing client segments, holding a combined 18% of global wealth in 2015. Nearly all of our wealth-manager survey respondents claimed to serve the over–$20 million segment, with 67% saying they wished to increase their share. Nonetheless, the diversity and complexity of the households that make up this category, as well as their investment needs, are evolving so rapidly that it is worth reassessing these segments.
Given the challenges of managing large investments across multiple jurisdictions, it is not surprising that very wealthy people typically need many banking relationships (roughly three to five) in order to find all of the products and services they need—including high-level portfolio management, estate planning, and tax advice covering multiple asset classes and countries. Individuals at this wealth level also typically seek diversity. In our survey of wealth management clients (our “client needs” survey, which included interviews), more than 80% of the over–$20 million segment expressed a willingness to invest in both alternative products and emerging markets. Socially conscious products were not seen as critical offerings, nor were social platforms that involve other investors. Crowd-funding platforms were cited as interesting by 30% of respondents.
People with more than $20 million in wealth tend to be knowledgeable about investment strategies as well as more self-directed—although they are also typically interested in close interaction with the professionals who manage their money. According to our client-needs survey, they rely first on themselves for investment decisions and on their advisors second, although they are especially concerned with feeling comfortable that their assets are being looked after carefully and securely. Most are interested in long-term wealth preservation as well as short-term wealth growth. Excellent investment performance as well as price transparency are, of course, key considerations in choosing a wealth manager.
More than three-fourths (79%) of respondents in our wealth-manager survey serve their clients at this level with specialized teams that are fully dedicated to managing their complex needs. Nonetheless, 15% of wealth managers also said that they had RMs and teams that served all segments—which can increase the risk of overserving smaller clients at the expense of larger ones. Players that offer truly customized attention to the over–$20 million segment will also benefit from client referrals among this highly exclusive network of people. According to our client-needs survey, the vast majority of such clients leverage referrals from other investors.
Another important segment is affluent clients, with between $250,000 and $1 million in financial wealth. These clients make up the heavy middle part of the wealth pyramid, holding 30% of global wealth and representing 6% of households. We see this group as a type of emerging segment, particularly since it has not historically been a target for most wealth managers and is losing even more appeal in a world of regulated advice. While all of the respondents in our wealth-manager survey said that they served the affluent segment, 58% of wealth managers said they planned to decrease their share over the coming three years. In our view, this may be a missed opportunity, as gaining share among affluent clients is a relatively direct way to generate revenues through volume, using a standardized service model that is appropriate to clients whose investment needs are typically straightforward. In addition, clients that move from the affluent segment into the HNW segment will have learned the benefits of professional wealth-management services early on.
Our client-needs survey showed that affluent investors are very price sensitive, although many do not understand their actual fee level. For 71% of our respondents, fee levels were a top-three criterion in choosing a wealth manager, which is particularly relevant in the current environment of increasing fee transparency. To minimize fees, most affluent clients maintain a low number of banking relationships. A wide variety of products is typically less important to them than price considerations.
Moreover, although affluent clients are relatively small investors, they tend to be engaged. Half of our survey respondents said they had an appetite for actively trying to enhance their returns—preferring to base their investments on their own opinions—and they typically use online sources to gather investment information and advice. Wealth managers therefore have an opportunity to convince affluent clients of the value that they can provide.
Digital capabilities are important for this segment, as affluent clients are accustomed to using a range of digital channels with their retail banks. They expect an intuitive digital process for advisory services from their wealth managers. One-third of our client-needs survey respondents cited digital sophistication as a top reason for choosing a wealth manager, yet only 7% of our wealth-manager survey respondents said that they had a targeted and individualized digital platform. Next to meeting clients’ demands, technology is also the most cost-efficient and regulation-compliant way to serve affluent clients.
Across all segments, wealth managers must recognize that properly articulated value propositions should take a client-centric perspective and describe specific benefits in terms of service levels, products, and interaction channels—as well as the cost to the client. Skillful execution in this domain will lay the foundation for providing a unique and engaging client experience.