Cash calls put pressure on business models at wealth firms

The risk aversion sweeping through wealthy individuals is putting pressure on revenue margins at private client wealth firms.

Scorpio Partnership, a business strategy adviser to the wealth management industry, pooled together the collective knowledge of 32 key industry individuals, controlling more than £200 billion in assets under management at the end of the first quarter, to measure where portfolio construction is heading.

The report, which was conducted on behalf of Royal London Asset Management, identified three emerging themes demanded by clients in the wake of  the crisis: transparency, simplicity and liquidity.

These demands have resulted in the dumping of traditional satellite elements, usually alternative assets, and their replacement with more traditional investments such as bonds and cash. Risk-free assets are the new core of portfolios, according to the research.

All those surveyed at the UK private banks and wealth management firms said cash would feature strongly in portfolios. None of those surveyed expected hedge funds or fund of hedge funds to feature in portfolios, while only 11% of wealth managers said they would play a role in client portfolios.

This shift in asset allocation reflects the need for wealth managers to create value, according to Scorpio, where the use of the likes of investment grade bonds to generate alpha has become prevalent.

‘The shift in construction of asset management models indicates a major change in investment philosophy,’ said Graham Harvey, senior associate at Scorpio Partnership. ‘Wealth managers are increasingly keen to demonstrate their role in wealth recreation for high net worth clients.’

But this new culture is stretching business models. Scorpio points out that the positioning of cash and bonds as pre-eminent has a significant impact for the industry as the gross margin on these products is significantly lower than the one they can earn from more aggressive or alternative products.

Scorpio’s research shows the margin on fixed income is in the region of 30 to 40 basis points, while for alternatives it is more likely to be in the region of 80 to 90 basis points.

The compression in margins from equities and alternatives to cash and bonds is changing the commerciality of the asset management model,’ Harvey said.