More Money, More Profitability Problems?

That was one of the many findings from a recent Cerulli report about the state of private wealth practices in the HNW and ultra-HNW (UHNW) marketplace. The study looked at wirehouses and other full-service broker/dealers, large investment banks, bank trust departments, and family offices.

Cerulli said wealthier clients are more demanding, more price sensitive, and often require customized services that impact profitability.

“The first asset threshold is $10 million in assets. At this level, clients’ wealth exceeds the IRS estate tax exemption, thus requiring more complicated (and customized) financial planning strategies. This may reverse expected economies of scale and cause profitability to decline. Between $20 million and $30 million, clients see themselves as “big fish.” They feel entitled to institutional pricing, further bringing down margins for the wealth manager. Above this level (more than $50 million), additional complexities are introduced by the family dynamic or issues regarding multiple countries of residency. Conflict management and international tax law can also become necessary,” said Robert Testa, Cerulli analyst and co-author of the report, in a press release.

Firms are employing strategies to combat declining profitability. A focus on referrals (90% strongly agree), becoming more selective with clients (85% strongly agree), adding new clients (84.2% strongly agree), making use of technology (73.7% strongly agree), and involving younger generations (73.7%) are all strategies HNW wealth management providers are using to improve their profitability.

That last initiative might make sense, as HNW advisers told Cerulli that one of the major reasons a family might switch advisers is when wealth is transferred to the next generation. The new generation might want to find their own adviser or manage assets differently than their parents. Overall, according to Cerulli, HNW families (with $5 million or more in investable assets) typically have a high degree of loyalty, staying with their primary adviser for more than 10 years on average.

Human capital remains the number one challenge for firms in the expanding high-net-worth (HNW) market. Nearly three-quarters of firms surveyed by Cerulli indicated that they are hiring for positions within their firms. Most firms, or 88%, use bonuses as a method for retention. “Demand for employees has increased dramatically at firms and compensation packages seem to be the most salient differentiator,” the report said.

Cerulli said it is difficult to compare fees across all types of wealth management providers, but in general, most (69%) operate with asset-based fees. Nearly 92% of firms surveyed have raised fees in the past three years.

Growing Market

According to Cerulli, the number of households with more than $50 million net worth (note: not investable assets) has more than quadrupled in the last 20 years. Households with a net worth of more than $5 million now represent 1.5% of the overall U.S. population and control 39% of the nation’s overall wealth. HNW wealth management providers reported that on average, 27% of their clients had a total net worth of $50 or more, and about 39% reported client assets of between $10 million and $50 million.

In the private wealth management space, traditional private client groups (including regional and national banks and trust companies) hold the largest marketshare (58%) of HNW investors. Wirehouses saw a 16% growth and now hold a 39% marketshare. However, Cerulli’s report said signs point to a possible erosion in client confidence within this segment due to perceive risks and conflicts of interest related to subprime and auction-rate preferred securities.

Multi-family offices saw the largest growth rate at 35%, but still hold the smallest share of the HNW market (4%). Cerulli said the family office model—also being adopted at some broker/dealers and banks—is becoming increasingly popular with HNW and UHNW families for its independent advice and open architecture (see “Celent Examines Future of Servicing Nation’s Wealthiest’).

Another trend for servicing HNW and UHNW investors seems to be in alternatives. Wealthy individuals are increasingly comfortable with alternative investments, Cerulli said. Forty-one percent of firms surveyed said they expect to increase allocations to exchange-traded funds (ETFs) over the next year or two.

The report is Cerulli Quantitative Update: High-Net-Worth and Ultra-High-Net Worth.