The drivers of private asset demand
Private assets (debt, equity and real estate) have long held a role in institutional portfolios, as they are comfortable trading illiquidity for returns. Individuals are now allocating greater sums here too and this has traditionally been chalked down to the current low return environment. Whilst financials are a factor, this article also explores the personal, emotional and intellectual drivers which are encouraging the shift to direct private asset investments across all wealth segments.
The "hunt for yield" in an environment where traditional “safe” investments struggle to keep pace with inflation is well known. It is an unusual environment where an advisor can get excited about their bank releasing new cash products at 80bps, and 10yr gilt yields have fallen below 1% in the wake of Brexit. Shouts of “return free risk” are becoming even more prevalent.
Advisors have rightly managed expectations down, but investors in diversified mandates have still seen little to no return for some time now. This is combined with greater transparency of fees that has arisen across most jurisdictions in the wealth management industry. With most TERs coming in anywhere between 1.5 – 3% (even including robo-advisors) and taking a significant chunk of returns away, it is no wonder the industry is coming under increasing pressure.
In the face of this, the potential risk adjusted returns of alternative assets are increasingly common. The premium of private equity over public equities has long been quoted and wealth managers with the capability and scale to access private equity funds are doing so in ever increasing amounts to help clients diversify.
The charging structure in private funds is a deterrent, however. A fund has to be stellar before an advisor can look a client in the eye and tell them that the manager is going to take 20% of all profits on top of charging you 2% a year (not just on the amount they have invested, but often also the amount you have committed, regardless of whether or not this is ever actually deployed). This is in addition to being charged for the privilege of accessing them via an initial placement fee and further annual fees for advice or servicing even though once you are in you are in.
Notwithstanding that, the drivers of why private equity is a successful industry help unlock the wider factors of why direct investing is becoming more appealing to high net worth clients. The ability to back a team, to influence and advise them, to take a long term view and help be part of that journey are all key reasons why private equity outperforms public equity. It is these same drivers which are encouraging investor appetite for direct private equity far beyond just the financial implications of these factors.
This desire to engage with the company and an individual’s belief in an ability to make a difference, form part of a wider conversation regarding the changing demographic and mind-set of today’s wealth management clients. It is a changing demographic who believe in being more hands on and more involved in their investments. This is the case regardless of whether investing in public markets or private markets, but the private markets afford them more opportunity to do so. They can look management in the whites of the eyes; they can visit their factories, understand their businesses and share insights.
It is not just about a new generation of millennials with a distrust of Wall Street but a key factor driving this changing mind-set amongst the HNW population is the source of their wealth. The entrepreneur is the single most important client group in most wealth management markets today. These clients are more likely to want to invest in sectors they know and want to share their experiences. This combines with their intellectual desires. As the exits happen at an earlier and earlier age and life expectancy and health increases, clients want to do more. Few clients want to go from 7 days a week to none and those that do find themselves getting bored very quickly.
The demand to satisfy their intellectual curiosity is clear. Some go apply themselves to charities, learn a language or lower a handicap. Increasingly though, many start a second, third and fourth business, apply their experience to help others or become more active in their investments. When doing so they want to buy in to a story as much as the potential financial return, they invest where they can be inspired and engaged.
This emotional appeal, intellectual curiosity and hands on approach means the efficiency frontier is no longer just about risk vs. return, it is risk adjusted return vs. passion. The right investment, private or not, is not just what delivers the best return but satisfies the clients the most emotionally. The growing trend toward behavioural finance has started to take account of this when constructing portfolios but the same is also true in private investing (and even more so in impact investing which we will discuss in more detail in later articles). The right direct investment is not just the one which has the best financial prospects but the one in which the investor gains the most enjoyment from.
Combining these emotional and intellectual factors with a changing demographic and mind-set in a low return environment makes it clear to see why the demand for private asset investing is increasing. What we will delve more in to in future articles will be where and how these investors are deploying their capital, the origination and decision making process and also how these areas vary across wealth segments and geographies as this trend is not just at the ultra high net worth and family office level.
But why should wealth managers care?
It is clear that HNW/UHNW clients are investing ever larger sums in private assets and increasingly via direct investments but this hasn't previously been a significant part of many wealth management offerings. Those that have engaged in the space have typically been fragmented, unstructured and not scalable, or only offered solutions focusing on connecting investment bank deal flow with the family office space or the top end of their UHNW clients. Here we want to look in to why wealth management institutions should increasingly be paying attention to a broader array of clients investing a larger portion of their wealth in to private assets.
Evolving propositions to meet the needs of clients
The first and foremost reason wealth managers should care about private asset investing is because it's what clients are now demanding. Clients are increasingly entrepreneurial; more hands on in their investments and their personas are more akin to that described previously, at a time when wealth managers are already lagging in their appeal to this client base. When this changing demographic is combined with the upcoming greatest generational wealth transfer ever known (Deloitte research suggests 90% of inherited assets change wealth manager, presenting a risk and opportunity), the need to evolve a proposition to meet these clients’ needs has never been clearer.
It is about evolving a proposition. Innovation should not just be about taking stagnant propositions and delivering them through digital channels, as technology has the power to enable new solutions and new approaches. When entrepreneurial wealth management clients, the key demographic for many institutions, have almost half of their wealth in private assets, having nothing to offer in this space yet still refer to oneself as a “holistic” wealth manager, or purport to advise on “every aspect of a clients’ wealth” is far fetched.
It is worth restating here that the passion, emotion and inspiration are as much a factor as the financial rewards in driving this desire for clients. This is important in so far as wealth managers, in the face of competitive pressures, increased transparency and low returns, are looking to differentiate themselves and justify fees on service levels and deep personal advice; to achieve this they need to play to the heart of their clients demands.
For a wide variety of firms, this emotional appeal is working its way in to the proposition through philanthropy services or a next generation offering. This is a very welcome step in the evolution of what they bring to high net worth and ultra high net worth clients. But to the entrepreneur, to the DIY investor, to the millennial and many more client personas direct investing creates just as much passion. The ability to engage over that £5m trust mandate is far easier if there are other aspects of the relationship that increase client interaction. A private asset offering can play a crucial role in strengthening relationships with clients.
We should also not overlook the important financial benefits of a private asset offering.
The clearest and most pointed way to assess revenue impact of a private asset offering is with those institutions that choose to directly monetise their offering. Those that charge their investor do so in one of two ways. The first is on a per transaction basis, typically taking a percentage fee based upon investment amount as an introduction fee or non-advised execution fee. Whilst this is highly demonstrable and tangible it is not without problems. The most common difficulty institutions face with this approach is having a pricing strategy commensurate with the level of value they bring and the larger the fee the larger perception of involvement and consequentially risk. The second approach is through a membership fee model. For this to work successfully there is also trade-off considerations when pricing appropriately but this time between making a meaningful contribution to profitability and ensuring enough uptake so as to facilitate liquidity.
Fee sharing arrangements with institutions bringing deal flow or charging companies within your network for the privilege of accessing your client base comes with conflict issues which need to be properly addressed and disclosed but, again, can also provide a highly successful way of improving revenues in the current difficult environment. Each of these direct monetisation strategies can have a strong and measurable impact to the business as this is typically a high ROA offering which does not suffer from the margin compressing competitive pressures of other more commoditised offerings.
For many good reasons a lot of institutions however prefer the more subtle approach to commercialising a private asset proposition. Some are more ‘subtle’ than others and would treat a private asset offering as more akin to a marketing tool. In this scenario they are relying upon tangible differences to their success in beauty parades or the increasingly varied conversations with clients to drive asset flows in to their core offering which in turn makes the financial contribution. Whilst this is clearly an advantage the most successful firms are more proactive. Using a private asset proposition as part of a targeted share of wallet and client referral programmes can have significant impacts on helping advisors achieve asset targets.
As one would expect though the right approach varies across institutions and depends very much on their client base and how they scope and use a private asset offering. It is crucial that an institution assesses the positives and negatives of different approaches. As we work with institutions building their private asset proposition, we are generating detailed analytics of which is the optimal strategy under which circumstances and we share this with our clients to help them build a private asset proposition that meets their clients’ needs and has a strong commercial impact.
Challenges of delivering a proposition
If it is clear then that direct investments are what todays high net worth clients want and wealth managers have the opportunity to build an offering in this space that would be beneficial to them. The next logical questions we see is; why are institutions not doing more in this space?
It is somewhat reductionist to answer this question with the simple retort of “risk!”. This does undoubtedly play a key role, particularly in face of the regulatory pressures facing the industry more broadly, but needs to be broken down in to components.
In our next piece we will delve more in to how institutions are currently building propositions in this space but crucially look in more detail at the multitude of legal, risk and compliance barriers that are preventing others from engaging successfully. This will be supplemented with an analysis of other key hurdles that need to be overcome such as client positioning, empowering advisors and building processes to ensure scalability. Technology can play a key part in overcoming the hurdles of building a private asset proposition and we work with institutions to solve these with our platforms but that in itself is not enough; a lot of thought and analysis is required to deal with firms on an institution by institution basis to build something relevant for them and their clients. This is where Delio continues to deliver.
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Articles will delve more in to such topics as what the wealth management industry is currently doing and where it is going, what private assets the UHNW and family office population are investing in and how they are making their decisions.
To find out more about how we are helping organisations to build direct private asset propositions that enhance their offering, please get in touch via our website or email email@example.com to arrange an initial conversation.