Opportunities for Action in Financial Services. Untapped Riches: The Myths and Realities of Wealth Management

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1 wealth management FS 09/01 9/13/01 1:41 PM Page 1 Opportunities for Action in Financial Services Untapped Riches: The Myths and Realities of Wealth Management

2 Untapped Riches: The Myths and Realities of Wealth Management After years of rapid growth stoked by steady doubledigit returns in the equity markets, the wealth management business is facing difficult times. More than ever before, competitive advantage is the key to success and sometimes even to survival. Indeed, growth for companies in this sector, which includes private banks and the wealth management divisions of banks and brokerages, is no longer a matter of rushing headlong to acquire assets and customers. Today s wealth managers need to reexamine their strategies, business models, and economics. In the course of their review, wealth managers will come to realize that their business has become clouded by myths. Some distortions might be tolerated in good times. But those times are gone. Financial institutions that aim to prosper in wealth management need to understand its underlying realities and thus discover the steps they must take to improve their franchises. To get growth back on track, financial institutions must sweep aside the following five myths. Myth 1: Wealth Management Is Always Very Profitable Conventional wisdom maintains that wealth management is a very profitable business for all providers. Like many other myths, this one is based on accurate premises: the wealth market is large and growing, and wealth management an attractive business with low volatility and high margins has lower capital needs than many other financial sectors. Nonetheless, in

3 the case of wealth management, the whole does not always equal the sum of its parts. Reality: Many wealth managers are only marginally profitable. A large number of wealth managers seem to make more money than they do. Because they use the assets and infrastructure of other parts of their parent companies, they are, in effect, subsidized. Research conducted by The Boston Consulting Group reveals that the wealth management businesses of many financial institutions underperform. 1 There are five main reasons why: Many wealth managers lack a clear picture of their economic performance, what drives it, and how it varies by customer segment. Because they segment their customers poorly, these wealth managers fail to align their service offerings with customer profitability. Many providers, marketing to customers with too much or too little wealth and showing too little regard for the behaviors of individual clients, fail to target those customers who genuinely fit their business models. The wealth offerings of many financial institutions need more customers and assets to be truly profitable. Not all wealthy investors are the dream customers they seem to be. Many of them drive hard bargains, and they are demanding and expensive to serve. Few financial institutions refer good wealthmanagement prospects across their various busi- 1. Richer Prospects in Wealth Management: Global Wealth 2001, a Senior Management Perspective, July 2001.

4 ness lines. For example, institutions retail banks, brokerage businesses, and insurance operations rarely pass along promising leads to their wealth management divisions. Most important, many financial institutions today find themselves supporting unsustainable cost structures for their wealth businesses. While they were overemphasizing revenue growth during the 1990s, wealth businesses ignored the costs of acquiring and serving their new customers. In light of these five factors, wealth managers must look squarely at the economics of their business to establish a true picture of performance. They must conduct a clear-eyed analysis of the costs of acquiring and serving customers, and they need to identify, target, and concentrate steadily on their best customers. Myth 2: It s All About Asset Management The term wealth management is often used as if it were synonymous with asset management. Reality: Although asset management plays an important part in wealth management, its role is often overstated. BCG s research shows that noncash investments, such as managed funds and directly held securities, account for only 41 percent of revenues in wealth management. (See the exhibit The Rich Buy More Than Investments. ) Most of the remainder comprises cash deposits, debt, and insurance products. Because many managers focus too much even exclusively on asset management, there is untapped demand and opportunity for wellintegrated offerings that incorporate loans and credit, as well as hybrid insurance-and-retirement products.

5 Institutions that offer only asset-management products may force their customers to seek providers that can satisfy their other needs, including tailored credit products, insurance, and trusts. By focusing narrowly on asset management, such institutions forgo potential revenues that many of their competitors are working hard to generate, and they deny themselves access to revenue that could support their cost structures. Furthermore, the players that are unable to satisfy customers many growing needs may find themselves The Rich Buy More Than Investments Global financial-services revenue from wealthy households by product category (2000) Directly held securities Managed funds Deposits/cash management Personally held debt Life insurance General insurance Private business debt $ billions Investments Deposits/cash management Debt Insurance SOURCE: BCG wealth management database.

6 relegated to being their customers secondary or tertiary provider. The solution is to offer products that answer each customer s individual needs, cementing and broadening the relationship while generating profits for the provider. Myth 3: Offshore Banking Is Dying The increase in regulatory intervention, relaxation of exchange controls, development of investment markets, and reduction of political risk in some countries have encouraged the perception that offshore banking is dying. Since the 1990s, significant portions of new wealth have been created onshore through initial public offerings and stock options, obviating the benefits of secrecy a primary historical advantage of offshore banking. Reality: Although the size of the offshore-banking market is likely to decrease relative to the overall wealth business, it will remain critically important for many of the world s wealthy. Investors have various reasons for using the offshore-banking market. BCG s research suggests that as much as half of offshore wealth is both legally and fiscally clean that is, its provenance and tax status are legal. For wealth managers, an offshore model provides an attractive option for extending the geographic reach of their institutions. Offshore operations can be global on a smaller scale and with much lower costs than a multinational onshore presence. Managers should therefore examine the offshore model and assess how well it fits with their current businesses and their customers needs. It may well be the best way to build global capabilities.

7 Myth 4: Wealth Management Is Only for the Very Rich Certain conventional wisdom holds that wealth management is all about serving the very rich. Reality: The emerging wealthy make up an increasingly important segment of the wealth management market. Some European banks have been successful defining wealthy customers as those who have as little as $75,000 in financial assets. That figure may seem low, but the growing consumer group known as the mass affluent is a very attractive prospect for ambitious wealth managers who carefully attend to the economics of their business. BCG s research shows that the emerging wealthy households with $250,000 to $5 million in investment assets hold $27 trillion, or 67 percent of the assets owned by rich investors worldwide. The newly rich are even more attractive in terms of revenue, generating an estimated $403 billion in 2000, or 79 percent of the wealth management revenue from all moneyed households. They represent a huge segment one that traditionally has been poorly served. More and more institutions are recognizing the importance of the emerging wealthy. It is unfortunate, however, that most providers do not fully understand either the group s underlying dynamics or economical ways to serve the increasingly complex needs of its members. Financial institutions must do a better job of studying the mass-affluent market, which in many countries is the fastest-growing segment of the wealth management business. If they serve the segment carefully, wealth managers will find that they can serve it profitably as well. What s more, many investors in this

8 vast market are on their way to becoming substantially richer. Myth 5: Wealth Management Is All About Protecting Money Traditionally, wealth management has been all about protecting the wealth of clients. In the past, rich investors faced a tradeoff between banking secrecy and performance, with many favoring the former. Reality: Performance is an increasingly important criterion for investors. As the nature of wealth creation changes and successful entrepreneurs steal some of the limelight from those with inherited wealth, performance is becoming an important consideration in selecting investment products and providers. This change in emphasis has significant repercussions for financial institutions. In order to attract new investments or merely retain existing ones, institutions require best-of-breed products. To acquire such products, many of them are adopting an open-architecture approach that allows a financial institution to offer customers its own products, as well as those of other financial-services companies. One caveat: mass-affluent investors are often more nervous about market volatility and thus somewhat more risk averse than richer investors. Wealth managers should adjust their offerings to accommodate this greater conservatism at the lower end of the spectrum. * * * The attractiveness of the wealth market is readily apparent, but misperceptions cloud many competitors understanding of their business. To operate

9 more effectively in an industry that will likely continue to experience rapid change and growing competition, wealth managers need to understand the true economics of their business. In short, they must examine their offerings critically to determine the gaps in their products and performance. Andy Maguire Andrew Dyer Paul Orlander Andy Maguire is a vice president in the London office of The Boston Consulting Group. Andrew Dyer is a vice president in the firm s Sydney office. Paul Orlander is a vice president in BCG s Toronto office. You may contact the authors by at: maguire.andy@bcg.com dyer.andrew@bcg.com orlander.paul@bcg.com The Boston Consulting Group, Inc All rights reserved.

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