The investment industry covers a large gamut of sectors. But they can be divided into three main intersecting parts: retail wealth management, institutional asset management and private wealth management.
What separates retail and institutional management from private wealth is that the first two have struggled since the 2008 financial crisis, whereas the latter has enjoyed unprecedented, record growth during the same period.
There are several reasons.
The 2008–2009 global recession hit retail brokers hard. Many had a fair share of their client portfolios in mutual funds, which were decimated. The rise of ETFs not only cannibalized the fund business, it created a new paradigm of fee pressure. Clients could now get an index-linked portfolio for a fraction of what they’d paid for mutual funds.
During this period, both fund and portfolio values plummeted to new lows. This resulted in massive revenue declines for advisors and dealers. Advisors were scrambling to find effective replacements for these funds — particularly investments that offered better yield to clients and margins for themselves.
In the case of the retail mass-affluent world, advisor-client loyalty depended on a mix of brand and manager performance. But after successive years of negative returns, even the biggest brands could not hold onto their advisor or investor clients.
At the same time, institutional managers suffered tremendous market depreciation and corresponding redemptions.
Measured against an index benchmark, during and after 2008–09 and then through the Covid pandemic, most managers were below their performance benchmarks. This resulted in institutional clients swapping managers. Many institutional managers suffered redemptions and client exits. It took them years to recover.
Institutional investors live and die on performance. It is the industry’s least forgiving sector.
There are two additional issues unique to institutional asset managers that both retail and private wealth managers don’t face:
- Institutional asset managers must build a minimum five-year track record to have any serious consideration by institutional investors.
- Institutional fees are far lower than those charged by retail or private wealth managers. As a result, institutional managers need much greater scale to be profitable.
Finally, many institutional clients are represented by an investment committee that represents unitholders. Since the relationship is not between the investor and portfolio manager, managers are less able to retain clients during periods of poor relative performance. It is an unfeeling, unemotional relationship. Only the numbers matter.
As a result, institutional managers are less attractive to buyer-investors. Fickle clients and low margins result in poor valuations. Unless the firm carries a significant level of assets under management, it will fetch a fraction of the multiple earned by private client businesses.
Some institutional managers recognized this and either switched to the private wealth side or added that component to their business. They were smart to do so.
Private wealth management
The private wealth business has unique advantages.
The fee margins make it one of the most profitable businesses in the financial services sector. These companies are attractive to owners, shareholders and outside investors. Private client businesses often command the highest valuations of any investment firm.
There are no formal time or asset investment hurdles for private wealth firms. Once registered, the firm is open for business and can sell directly to the public. Only sufficient capital and a group of highly competent, connected professionals stand in the way of scale. No track record, intermediaries or consultants are required.
The profit margins allow management teams to pay their salespeople via an ongoing recurring revenue model with no cap or time limit. That doesn’t exist in the institutional world.
Advisors are paid on a recurring revenue basis on the retail side, but the numbers pale in comparison.
Private wealth firms are also cost-efficient. Since most firms don’t hold funds or products per se, the client is only paying a fee for managing the client portfolio. Many wealth managers have pooled funds, but they are more cost-efficient than mutual funds. The client saves on fees and the managers enjoy greater margins.
Since most private wealth managers have their own core models/pools, the fees are split between the firm and the advisor-portfolio manager. These healthy margins make them among the most profitable and desirable of all investment businesses today.
Most importantly, client loyalty is not based on either brand or performance alone. It is the individual relationship between the portfolio manager and client that defines the success of the business model. This is why the private client business is often referred to as the one with “sticky money.”
Numbers tell the story
None of this is intended as a criticism of retail or institutional asset managers. I’m simply pointing out the natural advantages inherent in private wealth.
While the number of retail and institutional managers has remained flat since 2010, the private wealth industry has grown by greater than three times (based on the number of Portfolio Management Association Of Canada discretionary manager members).
So long as it is carefully preserved, the private-client relationship outlives performance and brand issues. It is highly elastic, weathering bull and bear markets. It is this unique quality that renders private wealth firms so attractive to employees, owners, clients and investors alike.
As a result, it’s not only banks and insurance companies courting wealth managers. Venture capital and private equity firms are swarming the wealth management community. As we have witnessed this year, they make up a growing pool of aggressive participants in the market.
While there continues to be marginal growth in the number of new fund and institutional managers, the Canadian private wealth business continues to outperform.