Retail Wealth Management
Retail investors are everyday investors without much buyer power. Generally, retail investors are individual investors with liquid investable assets of less than $1 million – although the allure of a more bespoke investment counsel is not compelling until $5 million.
The retail business comes with the highest fees, so at least on a gross fee basis, this offers the highest return on AUM. Retail investors largely invest in mutual funds or segregated funds, although there is increasingly a flow into ETFs (for example, iShares by BlackRock) for passive investing – sometimes via automated platforms such as robo-advisers.
Usually, the firms that have been the most effective in getting retail clients historically are those with cross-selling opportunities and distribution channels. Large mutual funds have strong relationships with banks, where they are able to pay a trailer fee to bank investment advisors to market their product. Mutual funds may also go through independent broker channels to be sold on a pure commission basis, although upfront fees (loads and deferred service charges) are disappearing amidst investor knowledge and ethical concerns.
In countries with concentrated banking sectors, the banks will have enough scale and cross-selling opportunities to have their own major asset management divisions. For instance, if a client goes to meet a financial advisor to talk about opening a savings account, the topic of mutual funds can be brought up. It should also be noted that in a concentrated banking market such as Canada (which has 5 main domestic banks), management expense ratios (MER) will be much higher than in a fragmented market such as the US.
For passive investing, Blackrock and Vanguard are able to get costs very low due to their scale and skill in replicating a benchmark index. However, they also make money via securities lending when other market participants want to borrow their stocks in order to short them.
Robo-advisors such as Wealthfront and Betterment charge fees based on money managed – the robo-advisors automatically rebalance portfolios which are constructed with low fee ETFs. Investing through robo-advisors means that investors have to pay both the fees on the ETFs in addition to the rebalancing/administrative fees. For robo-advisors, margins are very low, so the way to profitability is via scale.
High Net Worth (HNW) Wealth Management
High net worth clients are classified differently according to the jurisdiction and the relative prestige of the firm. At regional banks, the threshold for HNW usually falls around $1 million. At global institutions, the threshold will be closer to $5 million.
Although this technically gets investors access to tailored investment solutions in addition to alternative or private funds that are not available to retail investors, this does not necessarily constitute a benefit in terms of investment performance (nor are fees substantially lower at the $1 million-level). The attractiveness of this platform, in addition to the larger suite of products, is the bundling of services such as tax and estate planning.
At this level, asset managers collect fees for selling mutual funds, for providing tailored investing via constructing portfolios for clients and charging an annual fee (essentially a private mutual fund), or by charging a % based on AUM. Once assets are large enough, fees will fall for the investor, but will not fall as low as what institutional investors can get.
Ultra-High Net Worth (UHNW) individuals with liquid, investable assets above $25 million qualify for private banking. As a standalone product, HNW asset management is not that attractive – what makes it attractive is the bundling of services in a one-size fits all solution that can help finance a yacht, get a commercial mortgage and help their children get floor seats to the latest Taylor Swift concert.
The firms that sell to high net worth individuals are largely the same as the retail platform, but under a different series of funds which means increasingly lower fees once certain investment thresholds are met. Someone with $10 million in BlackRock will be paying much less per dollar of AUM than someone with $1 million.
Institutional Asset Management
Institutions that have money managed include pension funds (state, public and private), insurance companies, other financial institutions, non-profit organizations (Red Cross, World Vision), endowments (Harvard/Yale/Princeton) and corporates. The same dynamic applies – the larger the client, the lower the fees that can be negotiated.
The largest funds tend to be state investment funds/sovereign wealth funds and pension funds. These funds have a mandate to ensure their beneficiaries will be able to receive fixed payments over a certain time period.
Although many of the largest funds can hire the best and brightest to work for them and are good stewards of capital with returns that outperform their benchmarks, they also allocate money to third party alternative investments via external hedge funds and private equity managers. For example, the Canada Pension Plan Investment Board (CPPIB).
Due to the sheer scale of the assets, asset managers will aggressively pitch for the opportunity to manage pension money by cutting fees or having high watermarks to ensure returns. As choosing the right fund manager can mean a difference of billions of dollars, pension consulting/investment consulting and manager selection is a lucrative business (Aon Hewitt, Towers Watson, and Mercer are big in this space). An institution that looks to outsource asset management will work with consultants to find an appropriate manager based on factors such as performance, risk profile, fees and management tenor – with a preference for longstanding portfolio managers.
Recently, private pension funds have become a dwindling source of funds for asset managers as employers switch to defined contribution (DC) payments for staff where the employer is not responsible for paying a guaranteed sum after retirement as was the case for defined benefit (DB) pension schemes. However, for more egalitarian countries such as Canada, state pension funds like CPPIB have been given a mandate to expand.
We have prepared a Brief Guide to Asset Management, you can download it now.
Jason Oh is a management consultant at Novantas with expertise in scaling profitability for retail banks (consumer / commercial finance) and diversified financial service firms (credit card / asset management / direct bank).
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