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Serving the $1-5 Million Client Segment, Profitably

It has been a while since I wrote in these pages, and I have no true excuse other than an extremely intense period over the spring with numerous projects at peak stages of development. While things are not much calmer now (as I write from the airport awaiting a flight to Asia), a recent interaction spurred me to share some musings.

Last week I was interviewed by a prominent journalist in the field of wealth management, around the topic of the challenges in serving the high-net worth client segment with US$1-5 million in assets, in particular around how banks can profitably serve the segment. Since the interview naturally only scratched the surface, what follows is my more developed point of view on what is a critical topic for the industry.

First the context, in particular around why I feel this is a critical market to serve and to serve profitably:

  • MARKET SIZE: The $1-5 million segment cannot be overlooked by wealth management firms, not least because 90% of the total high net worth client base is found in this wealth band!
  • ACCESSIBILITY: On top of the large target market within the segment, while somewhat of a generalization, clients in this segment are arguably more accessible than the higher wealth bands, since they will already have a retail banking relationship that can be built upon, in some cases less complex wealth structures to manage, and may not have as high privacy requirements or political sensitivities, which can aid in prospecting.
  • DEMAND: There have been several behavioral studies done over the years, which show that high-net worth individuals with less than say $5 million in financial wealth do not “feel wealthy”. As a result, there is a strong demand for professional advice to preserve, grow, and pass on wealth.
  • FUTURE: Then there is the fact that wealth segments are dynamic. For example, younger wealth creators who firms are trying to attract, especially with “income” as the source of their wealth, will pass through this wealth band on their way to higher wealth levels during their lifetimes. At the same time, inheritors, even of significant fortunes, will often find themselves in this band since inherited wealth will need to pass through government taxes, a spouse (or spouses), and then several children, each of which will dilute the final amount inherited by the individual.

Now the challenge. There are several reasons why the $1-5 million segment is hard to profitably serve:

COST SIDE / REGULATORY PRESSURE: Significant regulatory pressure has significantly increased compliance costs, spanning people costs (e.g. the cost of hiring additional full time employees with legal and regulatory expertise, as well as increasing the salaries of compliance experts), documentation costs (e.g. revamping marketing materials and client communications including Key Information Documents (KIDs), tracking the legislation evolution, and updating and implementing new policies), IT and infrastructure costs (e.g. automating client on-boarding systems, upgrading existing software and hardware, and building scalable operations and infrastructure), and opportunity costs (e.g. lower wealth manager productivity on revenue generation activities, lost revenue, and de-marketing costs).

COST SIDE / WAR FOR TALENT: Firms are also dealing with ongoing talent wars, especially as the industry undergoes a seismic shift in its value proposition (moving from investment management to goals-based financial planning) as well as an exodus of retiring advisors, which negatively impacts cost structures by raising the cost of attracting, hiring, and retaining scarce talent (arguably even more acute in markets like Asia-Pacific). Given that personnel costs are one of the biggest operating expenses for a wealth management firm, this creates a significant challenge for firms to operate profitably, and hence they will deploy this precious resource where the profit potential is largest (see below, but due to prevailing fee structures this will usually be for the higher end of the wealth spectrum).

COST SIDE / OTHER COSTS: There are many other increasingly elevated costs in a very competitive market, spanning areas a diverse as legacy modernization, new digital channel demand and investment, change management initiatives, proposition development, client experience tools such as e-onboarding and performance reporting, and many others.

REVENUE SIDE / FEE PRESSURE: While costs are going up, income is also under pressure given that the primary income stream for wealth managers tends to be fees as a percentage of the assets under management. In the past, fees could be in the region of say 3% of AUM, which clients often paid with minimal negotiation. Anecdotal evidence from senior executives with whom I interact suggests the current conversation begins with a fee of 1% of AUM and then will be negotiated down to secure the business. If one assumes an individual wealth manager can really only serve 20 HNWIs in a holistic goals-based service model and each client “only” has $1m that is only $400k gross income ($20k fees multiplied by 20 clients) in a year. Such an amount sounds reasonable, but does not go very far since:

  • Around 50% of the fee goes to the firm for platform-related costs
  • Around 30% will go to taxes (a rough estimate)
  • The remaining $140k then needs to pay other professional expenses salaries of support staff (such as client service representatives, executive assistants, etc.), marketing costs (such a marketing campaigns, events, etc.), and travel costs, among other costs.
  • The wealth manager will then need some money for the basics of life, e.g. food and shelter (we will not even mention self-actualization expenses!)

REVENUE SIDE / COMMISSION PRESSURE: An additional income stream are commissions on trades, which are under threat from regulations (such as RDR in the UK) and client demands (we see that clients are far less open to paying over-inflated basis point commissions per trade, since online brokers do this for standard and lower flat fee and automated advisors now perform the same service almost for free). It is also part of a wider societal move on the part of clients away from trying to “beat the market” (which is increasingly being viewed as a fallacy) and towards tracking the market, which plays out in the rise of the low-cost ETFs at the expense of more profitable (for the wealth managers and fund managers) mutual fund.

One can therefore understand why wealth managers will focus their efforts on prospecting and serving the higher-end of the wealth spectrum, especially if the time/complexity to serve is similar. The result is that a wealth management firm in the current context is likely to reserve wealth manager provision of sophisticated client advice and planning for where the biggest asset pools lie, as that is where a firm will operate most profitably.

However forward-thinking wealth management firms will see the inherent opportunity in serving this segment, and invest and evolve accordingly. Unlike some in the industry, I do not think a firm can afford to label a segment comprising 90% of the target market as a “loss leader”.

Digital capability will be a key tool on the journey to profitably serving wealth individuals in the $1-5 million segment (and indeed will be critical throughout the wealth spectrum), as it helps address numerous objectives to profitably serving the segment. For instance, it can be deployed to reduce the cost of manpower, such as by automating processes in the middle and back office, as well as aiding wealth manager productivity through tools in CRM, documentation, remote working, and collaboration. Digital capability will also be key in enhancing client experience, across channel and service availability, convenience, experience (e.g. the integration of channels), and the availability of self-service tools (especially where the data store provides a picture to the advisor of these self-serve interactions that can be applied to the overall management of the client’s wealth). Finally, digital can also serve to aid strategic client targeting and marketing to the right client at the right time, such as by using digital channels and services (e.g. a low-cost white-labeled automated advisory service) as “on-ramps” to high-potential clients who do not yet have the sufficient wealth to qualify for private banking services (think of the young lawyer graduating from Harvard with hundreds of thousands of dollars of debt, but who within 20 years is more likely than not to be a high-net worth individual. Likewise, the use of third-party social prospecting tools will also be powerful in reaching a large and dispersed target market of $1-5 million clients.

However digital should be looked upon as a complement to the client-advisor relationship in the majority of cases, necessitating an evolution of the advisor value proposition (less emphasis on investment management as a differentiator, and more focus on holistic-goals based advice leveraging internal and external expert networks) while also enabling an option for pure self-service, if that is what clients want to do. After all, an ability to automate/self-serve will be important, since a significant amount of assets (and future assets) are in this lower band and retaining them on the platform is better than de-marketing completely and allowing competitors to take market share.

In summary, if I had but one paragraph to provide my recommendation on how firms can profitably serve this segment, my advice would be as follows: Do not ignore 90% of the market! Use two levers to profitably serve this segment: 1) Build hybrid advice models and employ digital tools to better prospect and more efficiently serve the client base; 2) Adapt hiring and training so that the advisors of the future can grow with clients… after all HNWI wealth is not static and they hold a lot elsewhere that can be consolidated.

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