Wealth managers to see hit on back of multiple market changes

22 August 2016 Consultancy.uk

Asset managers face an uphill battle to retain their hefty profit margins, according to a new analysis. The equity market and fixed income are projected to take a turn for the worse, while new legislation will require wealth managers to become transparent about their fee structures – which is likely to see the already fickle rich shop around for lower prices. Wealth managers can improve profitability by focussing on reducing costs and better managing clients.

The growing level of global high-net-worth-individuals (HNWI)* wealth, on the back of rapid growth in developing economies and appreciating equities over the past decade, has seen the total AuM increase by CAGR of 5%, from $52 trillion in 2007 to $71.4 trillion in 2015. Asset managers have, during that time, enjoyed relatively strong incomes. Recent reports, notably from the Boston Consulting Group, EY and PwC, have warned that the current state of affairs for asset managers is under threat from a range of fronts**.

A new report from Oliver Wyman and Deutsche Bank, corroborates previous warnings to the AuM industry about the changing conditions and the effect these factors may come to have on the sector. The report is based on interviews with wealth managers as well as HNWIs.

Market growth forecast vs industry growth projections 2015-2020

According to the firm’s analysis, a range of markets within which wealth managers invest are set to face headwinds. In the base case model for market development to 2020, equities are projected to fall from 10% CARG, over the period of 2002 to 2014, to 2% CAGR between 2015 and 2020. Fixed income is set to fall from 7% to 2% over the same period, while alternative assets will drop slightly, from 8% to 6%.

One of the areas in which AuM firms may be missing the mark is in their projections for market growth. In a survey among wealth managers, with a total of $11 trillion under management, the researchers found that the majority had market growth rates of between 8% and 10% to 2020 within their business plans. In relation to the economic modelling from the consultancy, which places overall growth at around 5% – there is a resulting total gap of up to 4% per annum until 2020, or $15 trillion by 2020. The firm is concerned that wealth managers will increase their risk taking, to meet their business cases – which could see an on boarding of a new wave of compliance risks.

Industry profitability projection 2015-2020

Besides decreased performance for their respective clients, a number of headwinds are also projected to place considerable downward pressure on profitability, which last year stood at a margin of 23%. The biggest hit (-8%) will come from fee reduction, resulting from a 16% reduction in 2015 investment product fee margins, while increased risk and compliance costs will see a total reduction in profitability of -3%. An increase in NIM will, however, boost profitability by 2%. To keep stable profitability, therefore, a total delta of 9% needs to be bridged.

The reduction in fees is driven by a range of factors, from increased competition between managers, to digital management to regulatory effects that are driving increased price transparency. The consultancy suggests, however, that price transparency will have the biggest impact, driven by legislation, including, among others, MiFID II/MIFIR in Europe and Canada’s CRM II.

Types of initiatives to close profitability gap

The consultancy suggests that the profitability gap or around 9% by 2020 can be reduced if wealth managers take a number of steps to reduce costs as well as develop new business models.

The top moves wealth managers can take include: reducing client churn through attrition management, a new focus on leveraging a range of channels to acquire clients, increasing access to alternative assets under management, and aligning regional footprints with growth hubs. The firm also suggests that a number of levers exist through which to improve the efficiency of the firm, and therewith, push down costs. According to the firm, this can be achieved by finding new ways to service the most valuable clients, as well as leveraging new channels to improve services, where possible – particularly looking at digital. Also, efficiently meeting increasing compliance costs, such that the cheapest mechanisms are implemented first time round, is an additional way of reducing costs and improving profitability.

Cost savings vs. automation potential by function

The firm also finds that a number of new technologies, which automate a range of processes, have considerable potential to deliver cost savings. Digital technologies, including automation, can, according to the firm, deliver more than just savings in cost – by, for instance, improving decision making and providing improved customer experiences.

The research suggests that back-office functions tend to be the most easily automated. The most profitable functions to be automated include KYC, reporting, operations, AML and risk management. Front office functions, such as succession, portfolio management and many aspects of client relationship are the least easily automated.

Christian Edelmann, a Partner at Oliver Wyman, says, “The growth of assets under management is likely to fall behind what wealth managers collectively assume in their business cases.”

* Those with more than $1 million in investable assets.
** See for more details the articles 'Wealth managers overestimate their skills and face digital disconnect' and 'Digital channels driving growth in wealth management landscape'.

×

The business and operating models of digital-only banks

04 April 2019 Consultancy.uk

In recent years, several digital-only banks have successfully managed to nestle themselves in the banking landscape, with their popularity continuing to increase. Looking at it from the customer’s point-of-view, there is little difference between these FinTech unicorns; looking at the bigger picture, however, reveals significant variation in their business models. Matyas Fekete, a consultant at KAE, explores some of the main similarities and differences in digi-bank business and operating models. 

What about the profit?

Unlike in the UK, in most of continental Europe, bank accounts and corresponding banking services are historically paid-for services. The fact that digital banks offer most of their services free of charge has undoubtedly helped them build a large customer base. On the other hand, despite comparatively low set-up and minimised operational costs compared to that of traditional banks, and given the lack of revenue stemming from the typically no-fee model, profitability has proved difficult to achieve. Monzo, for instance, recorded a net loss of £30+ per customer in its most recent financial year. 

In the start-up world, it is customary to focus on expansion rather than profit – see the case of Uber, for instance. Still, while profitability might not be their number one priority in their early stages of development, it must be a long-term goal of any business. With their ever-growing customer base, digital banks are increasingly under pressure to turn their business from loss- to profit-making. 

Credit where credit is due

Digital banks pride themselves on their fair (often meaning “free”) proposition and have so far stayed clear of offering loans (including credit cards & overdrafts), traditionally amongst the most lucrative products for traditional providers. Though somewhat reluctantly, newcomers are also realising that offering lending products is one of the most straightforward ways to offset losses made on their free, often high-cost services (e.g. overseas ATM withdrawals). Monzo, N26 and Starling have recently started offering credit products to their customers, with their loan offering expected to be extended to a wide range of services, from mortgages to overdrafts. Correspondingly, creating a lending portfolio can also pave the way for launching an interest-paying savings offering – a proposition seen as a basic banking product that is yet to feature in most digital banks’ portfolios. 

The business and operating models of digital-only banks

The premium customer

While most digital banks offer most of their products for free, some have extended their offering by paid-for premium services in order to create a revenue stream. As these premium features – including different types of insurance, unlimited free transfers/withdrawals, faster payment settlement or concierge services – are often offered in a subscription format, customers are typically prompted to pay for the full package rather than just the desired service(s), providing a significant revenue stream for the bank. Revolut, for instance, was amongst the first digital banks in Europe to break even earlier this year, a feat largely due to revenue from its premium subscription.

SMEs like digital too

Traditional banks typically service small and medium sized businesses under their retail rather than corporate banking arm. Having their product offering tested with consumers, and consequently gaining a reasonable customer base, digital banks have also identified SMEs as an ideal segment to extend their target audience to. The five FinTechs profiled have already gone, or plan to go, down this path by following up their consumer solution with a business account. While both propositions are typically built on similar features, some providers charge businesses a monthly subscription (e.g. Revolut), while others apply additional fees to specific services (e.g. TransferWise), banking on the expectation that businesses are more likely to be willing to pay for banking – something they are already used to doing. 

The marketplace model

While most digital banks offer a wide range of banking services, some of these tend to come from partnering with third-party providers. For instance, Starling Bank’s only proprietary product is its current account, which serves as a basis for the provision of ancillary services, ranging from loans to insurance, to investment opportunities. Instead of developing these services in-house, Starling enables a select group of partnering financial service providers access to its platform in exchange for a fee. In effect, Starling is using its customer base to create a market for its partners, charging a commission for each acquired customer. 

In such cases of digital banks applying this marketplace model, the majority of their income often comes from partners rather than customers. Naturally, only banks with a large enough customer base can be successful in this set-up, underlining the current intensity of competition amongst digital banks.

Banking as a Service

While customer-centricity is heralded amongst the main USPs of digital banks, some are looking beyond offering consumer-facing services to diversify their revenue streams. Starling, which is among the few digital banks built on its own proprietary platform, has recently leapt into the Banking as a Service (BaaS) industry, making its technology available to other start-ups looking to launch a digital bank. Naturally, this raises the question whether the two offerings could threaten each other’s success. Generally, as long as such partners operate in different markets, the two business lines should be able to thrive alongside each other. Further along the line, however, such partners could easily end up expanding their banking solution into the same market(s) as they aim for global success, and by doing so, becoming direct competitors. 

Different approach, same result?

It is fair to say that consumers in Europe looking to bank with a digital-only provider would have a difficult time finding relative advantages/disadvantages amongst the leading players in the industry. Still, despite the limited surface-level variety, exploring the business models of leading digital banks reveals different approaches to the challenge of making money. Alongside the more straightforward method of offering paid-for premium features/subscriptions, some are banking on the value that access to their customer base offers to third-parties, while others outsource their technology to neobanks wanting to focus on the Fin rather than the Tech. With competition amongst digital banks heating up, it will be interesting to see which business model(s) prove to be the winning formula in the long term.