Wealth Management Renaissance - Financial Simplicity

02Mass Portfolio Customisation & The Unique InvestorCopyright © Financial Simplicity Australia Pty Ltd 2012

1. Mass customisation consideredi. Mass customisation addresses parallel consumer needs

Consumer control is core to mass customisation. This motivation reveals

The Renaissance of Wealth Management

© Copyright Financial Simplicity Pty Ltd 2013

The Renaissance of Wealth Management | January 2013 102Mass Portfolio Customisation & The Unique Investor

Copyright © Financial Simplicity Australia Pty Ltd 2012



ContentsIntroduction 2

I. What is the wealth management renaissance all about? 3 i. Technology remains a key driver 3 ii. The rise of the investor in the context of social media 4 iii. The rebirth of financial advisory to consumer standards 5 iv. Market fragmentation and globalisation 6 v. Continued financial market regulation 6

II. Critical Challenges 7 i. Investor uncertainty – The paradox of primacy 7 ii. Continuing cost concerns 8 iii. Structural issues in global markets 8 iv. Insufficient retirement savings 9

III. Implications of five key renaissance attributes in context of critical challenges 9

i. Greater awareness and understanding 9 ii. Greater choice and trusted advice 10 iii. Greater control 10 iv. Greater transparency 11 v. Fairer remuneration 11

Conclusion 12





Introduction

Much of the world has experienced significant increases in economic prosperity in the past three decades. However, the global wealth management environment has never been more challenging, nor fraught, with the potential for misstep.

These pressures facing the wealth management industry are well recognized and much continues to be written about them. However, less is written about the key positive elements of change and, more importantly, what is needed to sustain these attributes of “new thinking” in wealth management.

We are seeing the effects of the failure to grapple with an increasingly complicated system now revealing serious structural deficiencies. These include, inter alia, highly leveraged investing and mass pooling of retail investments, both of which have emerged as key investor security policy issues. The infrastructure itself has been vulnerable to manipulation at the very highest levels and, as a result, there is a distinct gap between those who are benefitting from the system and those whom the system has failed to serve, namely retail investors. However, emerging slowly, and at differing rates, from a prolonged period of complexity, the global wealth management industry has entered a period of profound change.

Such is the scope of this transformation that it can be classed as a genuine renaissance, a period of complete renewal in which investors, not asset managers, have become paramount. The implications for this are, naturally, enormous and it is fair to observe that these are generally not well understood by industry participants. The continued inability (of governments, businesses and individuals) to comprehend actively the imperatives of, and opportunities for, these changes will, sadly, result in periods of great difficulty for some wealth management businesses. However, equally, those companies that are embracing the renaissance and are genuinely seeing the opportunities inherent within, will themselves undergo a period of tremendous growth. These organisations, along with the investors they service, will be the ultimate beneficiaries of the renaissance and will be the leaders of the future in wealth management.

This paper looks at five areas we consider to be most critical to the renaissance and, consequently, have the greatest implications for the future prosperity of the wealth management industry.





I. What is the wealth management renaissance all about?

Over the past five to 15 years in particular, several areas of profound change and renewal within the wealth management sector have been occurring simultaneously and, depending on the global region, at various speeds.

The first area, naturally enough, is the continuously increasing impact of technology. Innovations in technology have made, and continue to make, significant adjustments to the overall supply chain experience in all its component parts – from portfolio managers to back office administrators to investors. The continued influence of technology on transforming the wealth management model cannot be overstated and is discussed in more detail in Item I(i).

Technology’s direct impact on investors themselves is the second key facet of the wealth management renaissance. This is perhaps the one that has taken longest to come to obvious fruition. Investors of all shapes and sizes are now served by wealth management which was, until fairly recently, generally considered the preserve of the very affluent. Extending wealth management to the common investor, the second area of renaissance as it were, has created a very different complexion for the industry and has resulted in an entire new category of imperatives including personalization (Web 3.0) and mobile access. The incidence and importance of investors has not, however, resulted in a general feeling of security.

Lack of investor confidence can be attributed both to sustained volatility in financial markets and a decline of trust in the traditional financial advisory role. It is in this third area of the renaissance in particular that much work remains to be done.

A fourth and compelling area of the wealth management renaissance is fragmentation of a traditional consolidated market and the concurrent expansion of globalisation. This has resulted in considerable challenges for smaller wealth players in their efforts to build sustainable operations without traditional economies of scale while facing increasing volumes of information (and competition) on a literally 24/7 basis.

The fifth and final area of change to be reviewed in this paper is in the area of financial markets regulation. This is not new but, given its intensified activity in recent years, and its critical importance, it should be considered an important attribute and facilitator of the renaissance in wealth management. Its commercial implications are certainly profound.

i. Technology remains a key driverThe rise of technology has been the single greatest attribute of the renaissance in wealth management and permeates each of the four remaining areas. Fuelled by technology innovation in the 1990’s particularly relating to unitized (‘pooled’) products which solved the issue of managing efficiently a portfolio of assets on behalf of mass investors and the internet which connected investors with financial service providers like never before,

The continued influence of technology on transforming

the wealth management model cannot be overstated.

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wealth management has become truly global and almost overwhelming in scope. The combination formed the DNA of retail wealth management, which in turn fostered the DNA of the wholesale industry resulting in an industry comprising some 45,241 equity securities, 139,933 debt securities and 650,000 OTC derivatives today. Worldwide assets under management are estimated in excess of $122 Trillion.

Many forward-thinking businesses are benefiting from technology advances, particularly in the field of investor communication and portfolio management. However, those that are not embracing new tools and associated methodology energetically risk serious competitive decline and, more absolutely, elimination. Specifically, to increase operational excellence and consumer relevance, wealth management businesses need sustainable ways of directing and adjusting a myriad of tailored investment portfolios simultaneously and easily.

The way of the now immediate future appears to be toward “open architecture” product models. Open architecture’s approach is to offer a broad choice of funds and products to place investors in control of the investments they wish to select or dissolve. In an open architecture environment, investors have the freedom to choose, and manage, whatever products they choose without incurring traditional heavy fees. According to a recent industry survey, two thirds of wealth management firms confirmed their intention to expand the incidence of open architecture embedded in their investment solutions over the next two years.

ii. The rise of the investor in the context of social mediaPeople define wealth more broadly than ever before. In this, today’s investors are not just concerned with the growth of financial assets. They have a more holistic appreciation of what true wealth is and, as such, are more participative than yesterday’s investors many of whom subscribed to a disengaged, outsourcing mentality.

The interconnectedness of wealth management (fuelled in growing part by social media and an insatiable appetite for financial news) is making the universal pursuit of wealth less remote, more immediate and, as importantly for investors, broader in scope. Increasingly, encouraged by social networks, other considerations are being promoted as integral to the “investment mix”. These include: personal values, education, life experience, community activities, family and personal interests. Collectively, these attributes, combined with more traditional investor profiling, drive greater relevance of overall investor understanding. Increasingly, they are a valuable means of building more relevant portfolios in a structured fashion in order to manage investments more effectively.

Traditionally, wealthy people cost more to serve than the relatively less affluent: wealthy people also receive commensurately better service. Wealth managers aim to strike a balance between cost and revenue by delivering service according to extent of individual assets. However, this is beginning to change due, in large part, to a combination of technology innovation and the ability of investors to ‘spread the word’.

The way of the future appears to be toward

“open architecture” product models.

Today’s investors have a more holistic appreciation

of true wealth.

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Thanks again to profound technology advances, the vital ability to scale portfolio adjustments easily, deliver relevant client reporting and ensure continuous compliance makes it possible to provide genuinely tailored service to the mass affluent. This is just as well since increasing numbers of dissatisfied individuals are turning to social media and other outlets as a means of finding alternative service in the context of connecting with friends and business associates for advice.

Investors, fuelled by an expanding network of ready conversation via the internet are making comparisons between each other and then demanding more control and lower fees by their providers. This has led, in Australia in particular, to the rise of self managed superannuation funds that collectively total over $700 Billion. Self-managed superannuation continues to be the fastest growing sector of the Australian superannuation industry.

iii. The rebirth of financial advisory to consumer standards

In the context of increased investor importance, the way in which financial advisers view their customers is very important. A key change is the way in which the ultimate customer – the investor – is actually viewed. Once depicted at the end of the chain, the investor, as ultimate consumer, is now placed at the pinnacle of contemporary business models given that this is where the fees are derived. Investor values are increasingly referenced in articles covering new thinking in wealth management and management in general.

Increasingly, in line with their consumer-focused colleagues across different industry sectors, wealth managers are seeing that effective management must begin with individual values: these are the drivers of customer sentiment. Financial advisers and wealth managers have traditionally taken sizable cuts of their clients’ portfolios as revenue without transparent accounting. Far from “getting what they paid for”, clients were rarely, if ever, aware of what they were getting in the first place.

In private banking circles, fees in most developed countries have dropped by as much as 10-20% since the start of the 2008/2009 Global Financial Crisis (GFC). However, wealth advisers also remain the primary service channel for clients and the majority of firms expect therefore to continue investing in the adviser channel to assist servicing of clients. Given that reliance on the wealth adviser for client service is costly – detracting energies from asset-gathering activities – wealth management firms are investing significant resources in technology to support additional service channels. Within this key area of profound industry renewal, ground-breaking technology is also being deployed to improve online servicing capabilities and leverage dedicated service teams and call center efficiency.

The influence of smaller, leaner financial advisory players, or boutiques, utilizing new technology in wealth management markets is already transforming the way the rest of the market works. Fees across the wealth management industry globally are falling and, at the same time, are becoming more transparent. The intersection between transparency and fairness will force wealth businesses to provide online services and to invest in online systems that will provide sensible advice at low cost in a sustainable, secure manner.

The ability to scale portfolio adjustments easily, deliver

relevant client reporting and ensure continuous

compliance makes it possible to provide

genuinely tailored service to the mass affluent.

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The investor is now placed at the pinnacle of contemporary

business models.

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Wealth managers are seeing that effective

management must begin with individual values.

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iv. Market fragmentation and globalisationGlobalisation affects not only the way investors’ funds are managed and the information required for effective management, it also shapes the context in which the individual investor operates.

While one part of the traditional wealth management market is fragmenting into smaller, often locally-based, operations, the other end of the market is concentrating itself on ensuring integrated customer service to every part of the world. The smaller, more local players have a distinct edge in their own markets in servicing local clients, particularly those countries relatively new to structured wealth management strategy such as Brazil and China, for example. The rise of China and the Latin American block (between them accounting for the fastest growing share of affluent customers worldwide) has created significant implications for traditional approaches to customer service, speed of information and investment methodology.

The fragmentation of the wealth management market makes it attractive to new entrants that generally have cutting edge technology-driven business models focusing on online offerings and, where regional jurisdictions permit, financial advice.

v. Continued financial market regulationWhile regulation is a mature component of most western financial systems, it remains subject to continuous change and self-reinvention. The extent of the renewal, and the implications already emerging, make it a key driver of the renaissance. The Organisation for Economic Development (OECD) has expressed serious concerns over the funding adequacy for national pension schemes and has initiated a pilot project to investigate the situation over a two-year period.

Most recently, in the name of increased investor security, the Australian, Singapore and UK financial systems have demonstrated significant adjustments in their respective systems. In the UK, for example, structural reforms are a response to serious systemic inadequacies that had their roots in a complex state-based system and became evident in the GFC. UK regulators are looking to address these issues in a number of ways: These include establishing the Financial Conduct Authority (FCA) in 2012/2013. The FCA’s primary responsibility will be to regulate the business of all UK financial institutions in the context of more aggressive consumer protection and engagement.

A key systemic and structural change (and critical in the relationship between industry participants) is that the UK Financial Services Authority will no longer allow platforms and product providers to pay financial advisers unless there is total fee transparency. While the collective banning of commissions and rebates from financial providers will create considerable threats to the survival of some operators, it is welcome change for investors who have long sought clarity in the value of the services for which they pay.

The rise of China and the Latin American

block has created significant implications

for traditional approaches to customer service.

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In Singapore, the Securities and Futures (Amendment) Bill 2012 was a direct result of the GFC. Singapore has contributed to international efforts to develop global reforms which are driving to significant reregulation of financial markets. Singapore is moving specifically to strengthen protections for retail investors. The GFC highlighted the need to protect retail investors, particularly in light of the mis-selling of some investment products. Singapore conducted an extensive 3-year review culminating in 2010 and proposed a number of new measures directed at the sale and marketing of investment products, and put forward a number of proposals to protect the interests of retail investors. Singapore is also strengthening the protection of retail funds placed with capital market service firms.

In Australia, the financial system itself remains comparatively robust. However, for the past decade, commissions and financial adviser remuneration has been a subject of intense scrutiny and extensive industry debate. The GFC fanned consumer resentment over bankers’ fees, a trend that has gathered momentum through the channels of social media, in particular. Australia has introduced a suite of new reforms called the Future of Financial Advice (FoFA). These reforms are specifically designed to improve fairness, transparency and will address conflicts of interest that have constrained the quality of financial advice provided to Australian investors. This new era of increased transparency and investor control will start to address the quality issue as consumers reject organisations that may conflict with their principles.

II. Critical Challenges Notwithstanding all the excellent initiatives currently being considered and implemented in the context of the renaissance and the resultant progress being made in critical areas, the global financial system remains under moderate to severe duress.

i. Investor uncertainty – The paradox of primacyThe renaissance has placed investors at the centre stage but there is a need for them to share that stage with trusted advisers. In an interesting paradox, despite the rising primacy of the investor over the asset/wealth manager, and the greater potential insights yielded by scope and speed of information processing, investors are not feeling more secure than they were 30 years ago. As an example, the rise of online stockbrokers more than 10 years ago did not, as then predicted, lead to the demise of wealth management. This was due in large part to the fact that many of the clients, whilst seeking competitive asset custody and execution services, did not then, and do not now, feel sufficiently confident to manage their own assets. This is an important paradox and one of the main reasons why industry reforms have not been faster or more deep-seated.

In the last years of the 1990s and the first 10 years of the new millennium, the credit crisis combined with poor performance from falling asset values to increase dramatically the level of uncertainty among investors. As a result, the wealth management industry saw a flight to safety of capital to traditional safe havens such as government bonds and cash products.

Building mutual trust between investor and

adviser is critically important for the stability of global

wealth management.

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Building mutual trust between investor and adviser combined with a patient, resilient view of investing is vitally important for the stability of global wealth management. A great deal of money – critical long-term retirement money – has been lost (often forever) by investors who once believed the system would support and protect them. The process of making them believe again, and entice new appropriately-advised investors into financial markets, is a key priority for governments and monetary authorities around the world. The world’s financial institutions, irrespective of capital strength, rely on market funding. In the event of a prolonged debt crisis, and another major flight to quality, the global financial system is vulnerable indeed.

ii. Continuing cost concernsIt has been widely reported that cost pressures in wealth management remain severe and the majority of industry decision-makers feel more effective approaches to managing costs effectively are required urgently. Technology has proven to be a key means of reducing, and controlling, costs particularly since much of the current cost burden to business is generated by manual processes which can now be partially or, in many cases completely, automated.

Increasingly onerous compliance requirements under emerging regulatory regimes, especially in areas of the industry where there are natural conflicts between the consumer and service providers, are a prime reason for escalating costs. Given that compliance demands are not likely to lessen in the near future, particularly as regulatory changes gain momentum, wealth businesses must develop new technology-rich strategies and embrace innovations designed for automated, fail-safe compliance management.

Another of the many areas in which costs must be managed effectively lies in tracking management fees and reporting on these in a disciplined, repeatable manner. This is critical to adhering to emerging legislation in a number of jurisdictions and is equally important to building client trust discussed in the previous section.

iii. Structural issues in global marketsA primary cause for concern is the lack of certainty regarding funding for personal pensions. According to the OECD, governments will need to raise retirement ages gradually to address increasing life expectancy. This must be done in order to ensure that their national pension systems are both affordable and adequate.

Events leading to the collapse of major global financial institutions revealed catastrophic flaws in the structure of popular financial products, in particular Over The Counter (OTC) derivatives.

Eurozone and US debt problems continue to constrain growth and create uncertainty. Improving transparency and discipline in this area to mitigate broader systemic risks has been a focal point for financial reforms worldwide. However, the measures discussed earlier in countries such as the UK, Singapore and Australia have not yet been implemented or have not have sufficient time for their effects to be felt.

Wealth businesses must embrace innovations

designed for automated, fail-safe compliance

management.

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The collapse of major global financial institutions revealed catastrophic flaws

in the structure of popular financial products.

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iv. Insufficient retirement savings Insufficient self-funding for retirement is a key concern of many governments. As mentioned earlier, the OECD launched a pilot program at the beginning of 2012 to assess whether the savings of future retirees would be sufficient to fund them in their lifetimes. Currently, there is a significant pension gap in at least 12 OECD countries with net replacement rates from national schemes at less than 60%.

Over the next 50 years, life expectancy at birth is expected to increase by more than 7 years in developed economies. The long-term retirement age in half of OECD countries will be 65, and in 14 countries it will be between 67 and 69. As a result, increases in retirement ages are underway or planned in 28 out of the 34 OECD countries.

Retirement savings anxiety is keenly felt in the UK in particular due in large part to inadequate pension savings, rising debt, and long-term care expenses. This is a direct result of the current state-based structure driving a low voluntary retirement savings regime, and large unfunded pension programs.

III. Implications of five key renaissance attributes in context of critical challenges

The wealth management renaissance and continuing challenges across the industry have combined to yield some significant benefits and positive indicators of future improvements. Wealth management companies that pursue excellence in each of the following areas simultaneously can differentiate themselves from their competitors and build a sustainable cost-effective business of relevance (and therefore value) for their clients.

i. Greater awareness and understandingAwareness is a key area of focus for High Net Worth and mass affluent clients alike. Wealth managers are looking for distinguishing methods to beat peer benchmarks, earn best-in-class performance, examine cost containment strategies to sustain margins and attract new clients.

Almost 80% of respondents in a recent industry survey were employing a unique servicing model for each distinct client segment they service. Relevant technology innovations (those that allow for greater portfolio flexibility, security and mass scale) are critical to the competitive ability to tailor the client’s individual experience. Greater awareness runs both ways: the wealth manager must be more aware of the client he is servicing: equally, the client is much more aware of the products and services on offer. Today’s investors are not afraid to shop around, particularly given their extensive support networks built within growing on-line communities.

Differentiation remains a key challenge facing wealth management companies in an open architecture world. As a result, companies are increasingly looking to their business models to acquire and retain assets on which to charge fees. In order to succeed, wealth managers will not

It is estimated currently that UK workers face a retirement savings chasm of £9 trillion.

Wealth management companies can differentiate

themselves from their competitors and build a

sustainable cost-effective business of relevance.

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There is a significant pension gap in at least

12 OECD countries.

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only need to develop a robust model to support growth through their own staff and business partners, but focus on delivering knowledgeable, quality advice to clients whose needs they will likely need to understand more comprehensively than in the previous 15 years.

ii. Greater choice and trusted adviceInvestors are faced with numerous investment choices that include exchange-traded funds (ETFs), wrap accounts, principal-protected notes, segregated and hedge funds. To better understand these products and how they fit into their portfolios, investors are looking for trusted advisers who can understand their distinct needs. In addition, more timely feedback and greater accountability are vital to developing the trust necessary for investors to avail themselves of choices offered by their advisers.

Understanding that risk and return are key to their clients, technology to enhance compliance oversight and investment due diligence top the list of corporate investment in people and processes.

There is also pressure to move away from the concept of an annual or quarterly review in order to review as situations change. Instant portfolio rebalancing and modelling tools within a framework of continuous compliance make this imperative a cost-effective reality.

iii. Greater control As portfolio reviews are becoming more frequent and comprehensive as a result of the intersection of regulatory and client demands, more wealth management firms will invest in adviser desktop tools for client reporting, according to a recent industry report.

The trend to open architecture product choice is a direct result of technology innovation intersecting with new regulation and rising client expectations over the past 15 years. Under so-called guided architecture the distributor filters investment solutions on behalf of the customer. This perfect storm, as it were, has increased the pressure on wealth managers to offer investors a much wider range of non-proprietary investment products and has resulted in the disaggregation of investment product manufacturing from product distribution. 60% of global CEOs surveyed recently reported their intention to adopt an advice-led model with a comprehensive open architecture for externally sourced products within the next two years.

Nearly 80% of wealth managers plan to expand open architecture strategies using third-party products in the next two to five years and increase the sheer number of products on offer. This trend has the potential to drive profound change in wealth management.

Relevant technology innovations (those that

allow for greater portfolio flexibility, security and

mass scale) are critical to competitive ability.

The trend to open architecture product

choice is a direct result of technology innovation

intersecting with new regulation and rising

client expectations.

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iv. Greater transparency Pressure from regulators and investors for increased transparency are leading to declining margins and higher costs.

A majority of wealth management firms are employing strategies to improve online capabilities to help service end clients – more to improve client reporting than for research/ advice and wealth planning (though the proportion of firms investing there is not trivial). The investment in client reporting not only improves the client experience, but are clearly important to reduce the administrative burden on the wealth management adviser.

This is one of the most valuable advances within the context of the wealth management renaissance as it has lead directly to ensuring that the system is not only more effective but is also more equitable.

v. Fairer remunerationThe trend toward fairer adviser remuneration has been at the core of regulatory enhancements in each of the developed countries with comprehensive reform programs underway.

Many firms have already adopted an enhanced approach based on new thinking that results in charging flat monthly rates to assess risk tolerance. Based on individual investor profiles, this will help investors design widely varied investment portfolios that are managed on a daily basis through sophisticated algorithms. This is a particularly significant area of renewal within the renaissance and continues to be refined by new technology innovations.

Investment in client reporting not only

improves the client experience, but are clearly

important to reduce the administrative burden.

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Conclusion“Renaissance” does not necessarily imply an easier course but it can mean better when better leads to greater awareness, understanding, choice, control, transparency and, most importantly, fairer remuneration in wealth management.

This paper has reviewed areas in which wealth management in some developed countries has begun a process of significant improvement with respect to enhanced investor experience. It has also sought to highlight some of the challenges associated with those areas of renewed strength.

Overall, the fundamental wealth management model is changing. We are seeing an increasing number of examples that all use technology to build fully tailored investment portfolios at a fraction of cost charged by traditional wealth managers.

Firms are able to access data on millions of portfolios in order to obtain sophisticated and immediate rebalancing for portfolios tailored to client personalized rules, preferences and constraints. This data can help not only to manage returns more effectively: they can also illustrate the degree to which professional management fees have affected portfolio values of the portfolios in direct proportion to adviser input. The critical implication of this is that it can ensure investing is more secure and is not, what it has sometimes been in the past, not far removed from gambling.

In examining those areas of renewal, improvement and innovation, we have set out some of the critical characteristics of sustainable business operations. Those that are best placed to succeed are likely to be large international operations with extensive retail networks at one end of the scale. Or, at the other end of the scale, smaller, more regional operations with a distinct affinity for the local market are also likely to do well. Perhaps ideal strategies moving forward may be a combination of both.

Both models, however, will depend on technology innovation to deliver what are now increasingly fundamental attributes as opposed to business differentiators. As a result, the bar is getting higher.

For more information, please contact us at [email protected] or call +61 2 8960 6030.

www.financialsimplicity.com.au

We are seeing an increasing number of examples –

grounded in technology innovation – that use

technology to build fully tailored investment

portfolios at a fraction of traditional costs.

Firms are able to access data on millions of

portfolios in order to obtain sophisticated and immediate

rebalancing for portfolios to client personalized rules,

preferences and constraints.

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www.financialsimplicity.com.au

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Wealth Management Renaissance - Financial Simplicity