Making Money Make Money

The private banking industry is under more pressure than ever to deliver returns for its clients. Fortunately, technology and new types of products are there to help.


The private banking industry is under more pressure than ever to deliver returns for its clients. Fortunately, technology and new types of products are there to help.

Participants at LatinFinance’s annual Private Banking Round Table.

There’s nothing like several years of consistent economic growth to accelerate the wealth creation process, especially in Latin America where family groups own most of the region’s private-sector companies and financial institutions. According to the 2005 World Wealth Report compiled by Merrill Lynch and Capgemini, the number of high net worth individuals in Latin America grew 6.3% last year and their wealth rose 7.9%.

The private banking and wealth management industries are evolving rapidly. The global financial industry is becoming more sophisticated and interlinked. The needs – and expectations – of the region’s rich are also growing. Advisers and bankers must also cope with increasing regulatory burdens. Governments in Latin America, the US and Europe are becoming more intrusive as they struggle to control money laundering, tax evasion and terrorist financing.

Private banking, with about $30 trillion in customer assets under management globally, is a highly lucrative activity. The world has about 8 million individuals with $1 million or more in liquid financial assets who pay advisers some $250 billion in management and advisory fees each year. Latin America alone has about 300,000 rich people with aggregate wealth of $3.7 trillion. Although business is growing at 6%-7% a year, the private banking industry remains highly fragmented.

Serving the Client
Today’s private bankers also have to contend with more knowledgeable and more demanding clients than ever before. “Sometimes they are as knowledgeable as some of the industry professionals,” says Felipe Britto, senior vice president of sales and head of products at ABN Amro private banking. Britto spoke at a LatinFinance Round Table on private banking held in Miami in December. “The evolution of clients led to the evolution of bankers. Bankers are moving towards becoming product specialists. Clients are looking for not just relationship-oriented bankers, but also bankers who have something to say, who have an added value as a financial adviser.” Although this relationship is usually harmonious, it is nonetheless affected by underlying conflicts of interest between clients and their bankers, between bankers and providers of financial products, not to mention between bankers and regulators. Several new trends in the private banking industry – the rise of open architecture and the growing popularity of separately managed accounts – are responses to these challenges. Open architecture allows banks to sell products from third-party providers in addition to their own proprietary offerings. Separately managed accounts are professionally managed portfolios of securities tailored to meet a client’s specific investment objectives.

Although open architecture is becoming increasingly fashionable, few big financial institutions have begun operating on a truly open basis. “Financial institutions are trying to separate the relationship manager and the investment adviser. Institutions have become more open, there is a tendency to adopt open architecture. They are not trying to push their own products so much, even though today there are still big institutions doing this. Latin American institutions do keep very much to the old model,” says Santiago Ulloa, CEO of TBK Investments, a Miami-based family office.

Bankers are still under pressure to favor their own institution’s products over those of outside suppliers or of their competitors. Bill Pingleton, vice president for the Americas at fund manager Franklin Templeton International, says: “There are banks that say they use open architecture, but at the end of the day what I see is that it does come down to the personal relationship. If banks manage that properly, if they put themselves into a kind of a consultant role on an open-architecture platform, that’s the best-case scenario.” Private bankers then become free to select products or asset management companies based on performance. By the same token, he warns, “Once bankers breach or lose that trust, if they’re pushing product or chasing the latest return and they lose that trust, then the client will move on and start looking for someone else.”

Bankers realize perfectly well that relationships based on trust and advice – as well as high performance portfolios – are the cornerstones of their industry. “A salesperson is someone who pushes products. An adviser is someone who actually gets clients to do things for their own good, against their natural inclinations,” says Mohammad Baki, president at New York-based Overture Financial. “It’s about looking holistically at your wealth, asset allocation and goal-oriented planning, if you will. That’s the hallmark of wealth management.”

Federico Sanchez

Feeling Defensive
So it’s easy to understand why bankers sometimes feel defensive. Alex Fernández, senior vice president for investments of Citigroup’s Smith Barney division, says: “My feeling is that we’re basically client-driven. We have to be advisers, because clients will ask you to get 7%, 8% annual returns in US dollars without risk, and that’s not feasible.” He says that as the industry has evolved and matured, institutions have sought a different profile when they recruit private bankers. “The reality is that the products are the same, they’ve been around for hundreds of years: stocks, bonds, fixed income, currency, and commodities. They are just being packaged differently. We sell our knowledge of supervising these other advisers, and we keep them in line. That’s what I consider open architecture.”
The advent of open architecture means that banks have to differentiate themselves from their competitors as products become increasingly commoditized. Banks must also provide value to their clients to justify their fees. Cementing relationships based on trust is the natural solution to this problem. “I think the main thing that differentiates one organization from the other is the level of communication, that level of trust that makes you basically the center of the client’s financial services platform, where you deal directly with their accountant, with their trust attorney or their tax counsel, etc.,” says Federico J. Sánchez, senior vice president at Fiduciary Trust International. “You build upon their needs by being basically their quarterback or trusted advisor. That’s the only way that you can truly advise the client and add value.”

The proliferation of products threatens to overwhelm investors and their advisers alike. Baki says there are some 6,800 mutual funds available to investors that invest in equities, which is far more than the 6,000 stocks listed in the market. A good many of these funds are serial underperformers, indistinguishable from each other or at best do not meet a typical Latin American private banking client’s needs. “Now there are so many new product lines, so many new managers that have very little track records, that the due-diligence process that the institution has to do becomes a key point,” says Gerardo Moya, a relationship manager at ABN Amro. “You can have an open architecture with a thousand new products, but the client will not be able to identify or distinguish very important key points. The relationship manager is the one that has to actually drill and make sure that what he’s finally delivering to the client.”

Fortunately, the availability of powerful IT systems makes this process simpler, more efficient and more transparent. Banks provide basic services such as on-line statements and information, but technology also enables banks to optimize their service by using advanced management information systems and customer relationship management systems. These tools help bankers manage their relationships and oversee their sales staff. Sophisticated platforms also help banks retain clients. Once clients have integrated their financial affairs into a bank’s IT system it can be extraordinarily complicated and time-consuming to shift their business to a rival institution.

The collapsing cost of technology also enables smaller institutions that lack the resources or scale to invest heavily in advanced software. “Technology, open architecture and automation have granted some of the smaller players, regional banks and family offices access to the same level of products and services as big global players,” says Cesar Murillo, managing director of Americas business development at Overture Financial. Furthermore, smaller firms do not face the same conflicts of interest that affect gigantic integrated firms that combine investment banking, trading, research and asset management services. Technology also makes it feasible to separate custody of securities, a highly sensitive issue, from advice. Clients naturally insist that their assets be held at highly-rated global firms, yet they can also rely on family offices or boutique firms for advice. Investment advisers may move from one firm to another, but custody of client assets does not.

Felipe Brito

Separately Managed Accounts
The increasing popularity of separately managed accounts (SMAs) complements the rise of open architecture. In principle, these accounts promise investors tax-efficient management of their affairs, account customization and access to portfolio managers. Vincent Lepore, associate director in Chicago-based Navigant Consulting’s Financial Services practice, says: “There’s no question that separately managed accounts provide much better transparency. Clients get statements of their portfolios, they own ‘X’ number of shares in each of these securities, in each of these portfolios, and if they don’t like a particular stock in a particular portfolio because of the business they’re in, they’re able to tell their investment managers.”
SMAs offer numerous features, allowing clients free reign to pick and choose their investments, such as hedge funds, at relatively low cost. Better still, they impose discipline on clients by forcing them to take a more focused approach to investing. A separate account requires a legal contract in the US and most Latin American countries, creating a fiduciary responsibility between the product’s provider and the client. As a result, SMAs are usually highly diversified with a well-structured asset allocation process. They typically offer lower pricing too. Investment performance is about 100 basis points better than comparable retail mutual funds. Eduardo Oliva, senior vice president of investments at Citigroup, says: “The process has discipline built in. I don’t care what you do. If you’re going to be successful you’ve got to have a certain degree of discipline to what you’re doing.”

Navigant’s Lepore says: “Typically, a third-party investment manager in the separately managed accounts business gets paid a much lower fee than if they were managing a mutual fund, a hedge fund, an institutional account or a separately managed account that’s just a direct private-client relationship.” While clients understandably like to pay lower fees wherever possible, Lepore is concerned that inadequate remuneration will drive talented asset managers out of the business. “The fear in the industry right now is that a lot of mediocrity could result from the unwillingness of major institutions sponsoring these programs to pay their investment managers,” he says. “In the end it’s not sustainable. In the end, talent will go to where it’s going to get the best compensation. And currently that area from an investment manager standpoint is in hedge funds.”

Furthermore, managing SMAs is a highly complex process because there is a widespread lack of standardization. Clients are still not fully aware or sufficiently interested in the flexibility offered by SMAs. Investors in the US held $620 billion in these accounts in the second quarter of 2005, up more than 40% from two years ago, according to the Money Management Institute. Yet nearly half of SMA owners say they’ve never customized their portfolio.

Fees are a sensitive issue in the world of private banking since many clients feel – rightly or not – that they are overcharged, receive poor service and earn unimpressive returns. TBK’s Ulloa says that more than 80% of private banking clients do not trust their advisers, leading to a steady turnover of clients. “We usually try to audit every single account that we have, and in many cases we see people are overcharging the client. For example, they are really putting very big markups.” He says some professionals even charge commissions plus a markup, which is illegal in the US but poorly regulated in other jurisdictions.

“We’re in a relationship business, and trust is very important in that relationship,” Citigroup’s Oliva says. “I think that as long as you are transparent with regard to fees, that can do a great deal to resolve a lot of that perceived conflict that might be inherent in our business.”

And as banks focus more on segmenting and designing delivery models that range from a highly customized approach for large clients to a plain-vanilla strategy for smaller ones, they can become more transparent about their fees. Clients investing in highly customized products pay more, while those buying plain vanilla products pay less. Although a sophisticated client will pay lower commissions on stock trading than less worldly ones, as a rule only sophisticated investors will buy more complex – and more expensive – products.

Assuming continued growth and stability, wealth generation in Latin America should continue to accelerate in the years ahead. That means that the private banking industry will become a more important part of a bank’s business, be it a boutique, a local bank or a gargantuan global institution. Clients will become more discriminating, forcing the industry to become even more innovative. “Independent advice and innovative thinking will win out. Institutions that offer their clients access to global investment opportunities will win out,” says Overture’s Baki. “Historically this has favored larger institutions, but I do believe that regional players, family offices and independents will gain market share in the coming years by adopting emerging service platforms that allow them to compete on a level playing field.”