Strategy

Wealth report: Brokerage model increasingly inappropriate for very wealthy in US

A staff reporter 4 December 2002

Wealth report: Brokerage model increasingly inappropriate for very wealthy in US

Many of the wealthiest people in the world still call the US home, even though America's wealth has been eroded significantly because of the tech wreck and harsh market conditions. The country's ultra-high net-worth individuals — such as Bill Gates, who is worth an estimated $43bn; Warren Buffett, who is worth $36bn; and Paul Allen, who is worth $21bn — certainly have little to worry about.

Firms that cater for high net-worth investors, however, are beginning to realise the need to refocus their asset management strategies in order to attract more clients in today's turbulent markets.

The role of the broker

The lower end of the private client market in the US is predominantly broker-lead, dominated by firms such as Merrill Lynch, Salomon Smith Barney, Fidelity Investments and Charles Schwab. Barron's private banking survey recently named Merrill as the top private bank in the US in terms of assets under management. The firm has $604bn in assets under management and its $1m-plus clients have an average $2m to invest. Clients in the firm's $10m-plus range have an average of $17m to invest.

In contrast, Salomon Smith Barney's private client business (owned by Citigroup) reported an eight per cent decline in income on a year-on-year basis for the third quarter of this year, whereas Citigroup Private Bank recorded a 13 per cent rise in revenue. Citigroup stated that the increase reflected growing client trading activity, lending and structured product initiatives. Salomon Smith Barney is the second largest wealth manager in the US, with $401bn in assets under management. Its clients represent the lower end of the HNW market and have an average $1.7m to invest.

Salomon Smith Barney's strong brokerage model has been seen by some as suffering in the current markets due to its less advice-orientated strategy. Brokerage is less important for the UHNW market but even in the lower end of the market managed programmes, such as wrap and the advisor programmes of SEI investments, are becoming less popular as people are looking for advice rather than product and execution. In addition, the decline in number of the mass affluent individuals has meant that brokers are losing their steam somewhat on the wealth management track.

"In the ultra-high net-worth private client market, brokers have a definite role, but it's not huge because most of the super-rich don't rely on brokerage firms for asset management: they rely on asset management firms and they have custodians. In the $10m and under market, brokerages have a much more important role due to their history in the marketplace and because brokerages can access the people and acquire clients in this space more easily. In the lower end of the wealth management arena, people will also go to brokerage firms rather than to private banks if they have $5m or less to invest because they do not meet the minimum requirements of the big private banks," a family office consultant, who works with ultra-high net-worth clients in New York, told Private Client Management.

Josh Slater, a portfolio manager with T Rowe Price Private Asset Management, added that the main advantage brokerage houses have in the marketplace is their distribution but admitted that there are problems with the 'one size fits all' approach that brokerages offer. T Rowe Price provides investment management and counsel services to institutions and HNWIs who have more than $2m in liquid assets.

"The larger brokerage houses have a headcount of between 12,000 to 14,000 and are in all local communities. They have developed relationships with their clients and the distribution of such firms is so wide that it can have competitive advantages that are irrespective of investment management capabilities. I think where they run into a snag is that they try to scale their investment management business through wrap programmes and many high net-worth individuals want tailored portfolios," Slater told Private Client Management from his office's Baltimore headquarters.

"One of the main disadvantages of wrap programmes is that high net-worth clients are often sensitive to tax implications and the tax efficient part of investing can often fall by the wayside. Additionally, the fees associated with wrap programmes are sometimes relatively high because there are more parties involved in the investment process," he added.

Brokers have traditionally been important in the US private client market because they have an arm of their operation which takes companies public, which is how a lot of wealth is created, believes Rob Rowan, founder of the Family Office Exchange. FOX is an independent advisor to UHNW families on complex financial issues and choosing appropriate advisers.

"Someone who has spent 20 years building a business may or may not know about asset management but they will trust the firm that took their company public because the firm did a good job, so they'll leave an amount of their assets there for them to invest. In Europe, for example, the markets aren't as developed as they are here, so families have tended to become wealthy from a family-owned company. This means they get liquidity from a stream of revenue from the company, so they don't have affinity to a particular financial firm, which may offer brokerage operations," Rowan told Private Client Management.

John Duffy, managing director of the north-east regional client practice at JP Morgan Private Bank, believes that the tradition of using a brokerage and the sheer number of brokerages in the US are two of the reasons for its dominance in the affluent marketplace. JP Morgan Private Bank has some $91bn in assets under management, and it is chasing UHNW clients.

Its average investor has at least $25m in assets under management. Duffy told Private Client Management that the broker offered a very narrow approach to private wealth management and did not adequately service the needs of the very wealthy, which is why brokerage services are only part of his firm's approach to integrated wealth management.

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