Follow the money

The Nasdaq rout has obliterated vast amounts of wealth, but high net worth remains the last open frontier for asset managers.

The Nasdaq rout has obliterated vast amounts of wealth, but high net worth remains the last open frontier for asset managers.

By Rich Blake
January 2001
Institutional Investor Magazine

It used to be that the average person would perhaps meet one millionaire in his lifetime,” says a man who,s met a few, David Rockefeller, the 85-year-old former chairman of Chase Manhattan Corp. and the grandson of oil titan John D. Rockefeller. “Now you bump into them on the street.”

Not quite. But the greatest economic expansion in U.S. history, coupled with an unprecedented and, until recently, unstoppable bull market, has sparked an extraordinary surge in American wealth. Never before have the rich been so ubiquitous, so visible and quite so, well, rich. The idle fifth-generation heir may still clip coupons at his summer cottage in Newport (though he is just as likely to check his foreign equity portfolio against the EAFE index). But he has been joined, and even eclipsed, by avatars of New Economy wealth: software barons, telecom entrepreneurs and those lucky anonymous engineers who signed on at a couple of start-ups called Microsoft Corp. and Intel Corp. , and even some now-struggling dot-coms.

To be sure, the high-net-worth market is a far cry from what it was a year ago. The Nasdaq’s rout (the index fell 38 percent last year and is off nearly 50 percent from its March high) obliterated a vast amount of wealth. But staggering sums remain intact. According to VIP Forum, a Washington consulting firm, the collective net worth (real estate included) of America’s millionaire households fell from $19.7 trillion at the end of March 2000 to $17.5 trillion at the end of November. (A March 2000 Sanford C. Bernstein & Co. study that excluded real estate pegged the U.S. high-net-worth market at $10 trillion.)

It’s no surprise then that the private client business has attracted such intense interest. Though high-net-worth money managers report net margins that slightly lag their mutual fund counterparts , a 33 percent versus 35.6 percent median, according to a recent Investment Counseling survey , the market holds much greater promise because it is so big, and so very fragmented. By most accounts, no single firm claims more than a 2 percent market share, making the territory perhaps the last open frontier of money management.

There are other appealing factors as well. Wealthy clients offer greater “wallet share,” tending to put more of their assets with one adviser than do ordinary retail customers. And they also tend to stay put , their assets, in the lingo, are “sticky.”

“If you deliver quality client service and solid investment returns, high-net-worth clients are as loyal as they come,” says Fiduciary Trust Co. International CEO Anne Tatlock.

A global battle to manage these fortunes is now roiling the financial services industry. This free-for-all , featuring mergers, acquisitions, strategic alliances and some very aggressive marketing , pits soft-selling private bankers who once owned the carriage trade against nouveau riche investment bankers who know how to close a deal. The old guard at Fiduciary Trust, Bessemer Trust Co., Wilmington Trust Corp. and The Glenmede Trust Co. are fighting to fend off Wall Street’s hulking brokers and bankers.

“Private wealth management has taken center stage here since we went public,” says Peter Kiernan, a managing director in the ultra-high-net-worth group at Goldman, Sachs & Co. “The real question is, Why didn,t we do it sooner,”

Not surprisingly, some of the biggest financial services deals of the past year involved high-net-worth money managers (see table). The most startling news, and the one that set off the past year’s deal-making frenzy: discounter Charles Schwab Corp.'s $3 billion acquisition of U.S. Trust Corp. in January 2000. Five months later, Alliance Capital Management, 60 percent owned by French insurance giant AXA, bought Sanford C. Bernstein for $3.5 billion (of Bernstein’s $85 billion in assets under management, roughly one third represents high-net-worth clients). And in October, Franklin Resources announced its $910 million purchase of Fiduciary, a 69-year-old trust company with $50 billion under management, of which $14 billion represents high-net-worth accounts, by far Fiduciary,s most profitable division. Each of these three big deals sported a price-to-earnings multiple of 30 or more. In comparison, asset managers usually trade at a P/E of 18 or 20.

“Ten years ago nobody wanted anything to do with the private client business. Now everybody is after it,” says Prince. And it’s a business that firms can build overnight. Hence the rush to buy. Says CEO Tatlock, “It takes years to develop the kind of reputation you need to succeed in this business.”

It’s a global game. In April HSBC Holdings and Merrill Lynch & Co. announced a jointly owned online wealth management business that will provide online banking and brokerage services for wealthy individuals around the world. To strengthen its private banking operation, Credit Suisse Group in November bought the U.K.'s JO Hambro Investment Management, which has £1.5 billion ($2.2 billion) in high-net-worth assets under management. At about the same time, Credit Suisse and Microsoft unveiled a pan-European alliance that will incorporate Credit Suisse’s private wealth services into Microsoft Network’s MoneyCentral, an online personal finance portal.

The push for high-net-worth assets overseas has gathered steam in the past five years or so. For decades that market was best known for its stealth and secrecy. Most famously, Swiss banks offered anonymous, numbered accounts so that wealthy investors could escape scrutiny , and taxes. If they had to sacrifice decent returns to guarantee their anonymity, so be it. In recent years, however, as such privacy has proved harder to secure and foreign countries have generally liberalized their highly regulated economies, European and Asian investors have begun looking for better returns on their investments.

The changes make for a more receptive environment for the U.S. banks that are fighting to snare the accounts of well-heeled foreign investors. The Citibank Private Bank, for example, which actively courts high-net-worth Asian investors in Hong Kong and Singapore, added $4.4 billion in assets in the past year, almost all of which was new money. “The wealthy Asian is now less concerned with secrecy,” says Steven Lawrence, regional head of Citibank Private Bank in Singapore. “Asians are more concerned with service, objective advice and performance.”

For the moment, suggests Morgan Stanley Dean Witter analyst Henry McVey, U.S. money managers will find it difficult to compete for the accounts of the European rich. “Don,t hold your breath,” he says. “It will be difficult for U.S. firms to capture this money.”

At its highest end, there are as many varieties of high net worth as there are firms pitching the business. Different money managers target vastly different slices of the market. Some firms, such as PaineWebber, willl accept as “private clients” anyone with just $500,000 in investable assets. The broadest group of players, including Bank of America, Citigroup and Merrill Lynch, require clients to show $1 million in investable assets, the common definition of high net worth. (A survey of 350 private client asset managers by consultant Russ Prince found that the largest percentage, 58 percent, set their minimum accounts between $1 million and $5 million.) Others like Goldman Sachs target clients with investable assets of at least $10 million. Goldman fields a special team that focuses on clients who have recently enjoyed a “liquidity creating” event that netted them $300 million.

At almost every level, the business demands consistent performance on a variety of fronts: asset management; brokerage; alternative investments, trust services and accounting; tax planning; charitable and philanthropic advisory services; and legal and estate planning, as well as such “soft” personal services as family counseling and wealth responsibility education. It’s a high-touch business. Attracting and serving wealthy investors requires a subtle approach: mass marketing techniques simply do not work.

“This isn,t a one-size-fits-all business,” says Sanford Schlesinger, a New York,based trust and estate attorney with law firm Kaye, Scholer, Fierman, Hays & Handler. “To compete, you really need to provide a full breadth of services, but also the intangibles. And the new-money crowd wants to be catered to just as much as the old.”

But, Schlesinger adds, “while old money is accustomed to parking the assets with an adviser and saying, ,Here, do whatever you think is right,, the new-money crowd is more prone to get involved, to challenge the adviser.”

Generally, though, once the assets stick, they stick for a good, long time. Mellon Financial Services, which manages $60 billion through its Mellon Private Asset Management, found that from one year to the next, the firm kept 98 percent of high-net-worth client assets, compared with just 22 percent of retail client assets. “That means for every dollar we bring in on the retail side, we get to keep 22 cents the next year,” says chief operating officer Christopher Condron. “You can see why we value the high-net-worth business.”

American private wealth management began as a family affair. In the late 19th century, patriarchs of the nation’s wealthiest families, including Astor, Carnegie, Morgan, Rockefeller and Vanderbilt, formed the first generation of high-net-worth investors (though the label probably didn,t appear until the 1980s).

Many of these titans established trusts to protect their heirs, and family offices to safeguard and manage their fortunes. Such offices include Brown Brothers Harriman & Co., founded in 1818; J.P. Morgan, founded in 1864; Rockefeller & Co., founded in 1882; and Bessemer, founded in 1907.

For decades, roughly from the turn of the century through the 1970s, the vast majority of high-net-worth investors placed their money with private banks and trust companies. These institutions courted and attracted the rich and well connected, many of whom came to the banks through referrals from friends, attorneys and accountants.

Through the early 1980s, most of America’s superrich had inherited their wealth. One measure: In 1984, 60 percent of the Forbes 400 represented inherited money. Last year that percentage had fallen to 34 percent.

The go-go ,80s, of course, began to redefine the meaning of wealth. New fortunes emerged from booms in real estate, leveraged buyouts, mergers and acquisitions. In 1983, according to Edward Wolff, a professor of economics at New York University, about 48,000 households owned assets of at least $10 million. A decade later that number had more than tripled, and today there are more than 300,000 $10 million households.

In 1992 U.S. high-net-worth assets totaled some $4 trillion, a sum roughly equal to all pension and mutual fund assets. (Today U.S. pension and fund assets total some $18 trillion, about $8 trillion more than high-net-worth assets.) Still, in the early ,90s most money managers and brokerage firms focused their efforts on the fast-growing market for retail mutual funds and defined contribution plans. Middle-class Americans had embraced equities, and there was plenty of money to be made.

“The high-net-worth market was viewed as extremely challenging,” explains consultant Prince. “These rich people are very hard to find. It was a business heavily reliant on referrals.”

By the mid-1990s, though, asset managers, investment bankers and brokerage firms, a new guard of high net worth, saw real potential in the private wealth business. “Over the past two years, we,ve seen a tremendous shift , as big as anything I,ve seen on Wall Street,” says Philip Murphy, head of Goldman’s private client unit. “Every major bank is trying to move into a business that has traditionally belonged to private bankers.”

In Goldman’s two-year-old division to attract the superrich, the firm specifically targets entrepreneurs who became rich through Goldman-led IPOs. “When that moment arrives, you can just see it in their eyes,” explains Goldman’s Kiernan. “The person is suddenly awestruck. It dawns on them that their lives will never be the same.”

Investment banks may enjoy an edge in their ability to monetize a company founder’s low-basis stock, using derivatives and hedging strategies to make some portion of the stock position liquid. As a group, brokers and investment bankers also tout their access to top-of-the-line money managers, hedge funds and wealth protection strategies, as well as superior technology. “We tell potential clients, ,Look, if you want tea served in gold-rimmed cups at a mahogany table, then go to Bessemer,,” says one high-end Merrill broker. ",If you want cutting-edge technology and the broadest array of products available, come to Merrill.,”

Nonsense, reply the private bankers, who stress their own ability to offer disinterested financial advice. Above all, they promise a personal touch. “I,ll tell a client flat out that at a firm like Goldman or Merrill, you just won,t have access to senior people,” says Peter (Tony) Guernsey, president of Wilmington Trust.

“The large financial services conglomerates clearly view their clients as captive distribution targets for their products,” says James MacDonald, CEO of Pell, Rudman & Co., a Boston-based private asset manager. Still, the bankers are not shy about selling, and they are busily opening new offices. The Citibank Private Bank, which employs 450 private bankers around the world, expects to add an additional 100 to the roster, says Peter Scaturro, who heads the operation. “There,s a shortage of talent right now,” he says. “We can,t hire people fast enough.”

Pat McCrossan, director of marketing at Glenmede Trust, argues that Wall Street’s new attention to the private wealth market actually highlights the expertise of the old guard. “People are finding out who has been in this market,” she says. “It’s heightened the awareness of who we are and what we can do. But we know we can,t be complacent. Would you want to go up against Goldman Sachs?”

Who is winning this battle for market share? No one produces hard data on this very sensitive subject. But research from New York consulting firm Spectrem Group suggests that the brokerages emerge as the primary adviser to most high-net-worth investors, a role that belonged to banks a decade ago. Out of a group of 600 individuals with assets of at least $5 million, some 43 percent indicated in a recent Spectrem survey that full-service brokerage firms hold the bulk of their money, on average about 30 percent of assets, with an average account balance of $7 million.

Yet consultant Prince will soon release a study that suggests that brokerage firms may be losing their grip on new money. He asked a group of more than 500 so-called e-millionaires , people who have made their fortunes in technology-related fields , how much of their assets was placed with the investment bank that took them public. For the period immediately following the IPO, the average is 90 percent. For the period three years after the IPO, the average falls to 40 percent. Some of that shift no doubt reflects the fact that the value of their stock fell as well, and the IPO rich, being human, thought their investment bankers were partly to blame.

Says Prince: “Over time, as these individuals began to move in different social circles, they are increasingly targeted by money managers. Basically, they go from being a nobody to a somebody. Well, guess what? They start to move their money around.”

Perhaps private client assets will become less sticky as more and more New Economy wealth makes its way into new private client accounts. Certainly, it has never been easy to gain the loyalty of high-net-worth investors, which is one reason financial services companies are so eager to buy money managers that have developed their expertise over decades, not years.

From the office he still keeps at the family firm, David Rockefeller offers his own personal judgment on managing American wealth, honed over many decades: “This is a good business to be in if you know what you,re doing.”