Morningstar Magazine - June/July 2017 - 57

Dusting Off Wealth Management
An old, established industry can still
thrive if it embraces change.

EUROPE

Ali Masarwah

Encompassing much more than simply creating
financial plans and running portfolios, the
European wealth management business has long
thrived on complexity. Because it also coordinates
retail banking, money management, estate
planning, and tax and legal advice in a highly
personalized fashion, the industry has been able to
protect itself against structural changes. It has
prospered on the hefty fees banks charge its
customers due to high barriers of entry, ample
"gray money" pouring into Europe, as well as holes
in local taxation systems. High capital market
returns-driven by high interest rates and buoyant
equity markets-contributed to lifting margins.
And charging fees based on a percentage of assets
under management is a lucrative fee structure.
These good times are still reflected today in
valuations of banks' wealth management units.
According to a study by Deutsche Bank and
the consulting firm Oliver Wyman on global wealth
management, leading players with combined
AUM of $11 trillion accounted for 37% of banks'
valuations, compared with 16% before the
financial crisis in 2007. This compares to a 28%
share of revenue, the study says.1
This high-margin business, however, faces
challenges to the core of its business model.
Several factors are contributing to the erosion of
margins: increasing regulatory pressure; rising

compliance costs; the advent of new, disruptive
technologies that have bred new competitors;
and ultimately, the loss of client trust due to poor
investment returns during the financial crisis.
These factors could be compounded by less benign
capital markets. With equity valuations stretched
and the continuation of the multiyear bond
bull market unlikely, asset performance as a growth
factor for wealth managers is under question.
The base-case assumption of the Deutsche Bank/
Oliver Wyman report sees AUM growth of 5%
annually through 2020, down from 7% in the past
five years. (The bear-case scenario sets AUM
growth at only 2% to 3% annually.)
This article will explore the industry's challenges.
These can be summed up in three key aspects:
regulation, trust, and technology. While our focus
lies on European wealth managers, these factors
confront wealth managers globally. While
disruption arguably will lead to the consolidation
of the industry, it need not only be seen as a
threat. Change and challenges offer opportunities
for innovative and flexible incumbents.
Regulation: An Important Driver of Transparency
After the financial crisis, waves of regulatory
measures hit the banking industry. In Europe, the
Markets in Financial Instruments Directive, known
as MiFID II, is expected to have a sweeping impact
on the financial-services industry. The far-reaching
rules, which are set to start in 2018, cover
investor protection, fee transparency, internal and
external controls, and market structure.

Fee transparency is the Achilles' heel of the wealth
management industry, which has thrived on cost
opaqueness (and correspondingly cost insensitivity
on the behalf of investors). It is expected that
fees levied by wealth managers will now come
under scrutiny. According to a survey of highnet-worth investors by Oliver Wyman, 75% of the
European respondents said they are willing to
switch wealth managers if offered a 20% discount,
compared with only 25% of U.S. investors surveyed.2
"The extent of the problem may even be
understated," the authors say, "given almost half
of all surveyed respondents...aren't really aware
of the price they are paying, which impending
regulation will start to change."
According to the consultant Capgemini, investors'
preference for fee structure is changing already.
While wealth managers traditionally charge
fees as a percentage of AUM, investors say they
prefer performance-based fees ( EXHIBIT 1 ).3
Increased fee transparency also will affect the
types of products that firms offer. Under MiFID II,
advisors will need to deliver suitable advice
and recommend investments that are appropriate
for clients' needs. Similar rules have already
been implemented in the United Kingdom in the
framework of the Retail Distribution Review,
or RDR, and in the Netherlands. In Switzerland,
two high court rulings in 2006 and 2012 ordered
that retrocessions paid by fund providers to
wealth managers must be redeemed to investors.
The consequences of these actions have been a
surge of flows into exchange-traded funds and
open-end index funds. According to Morningstar's
asset-flow data, inflows into passive funds
domiciled in those three markets have picked up
markedly in the past years, while flows into
actively managed funds, which were typically sold
under the past distribution regimes, have faltered
( EXHIB IT 2 ). The flows of Swiss-domiciled index
funds have actually topped those of actively
managed funds in every calendar year since 2013.

1 Deutsche Bank Research & Oliver Wyman. 2016. "Running Faster to Stand Still," White Paper.
2 Ibid.
3 Capgemini. 2016. "Top Ten Trends in Wealth Management 2017," p. 22. White Paper.

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