Month: July 2014

Forced to contend with regulatory changes and an increasingly competitive environment, the wealth management industry has had to take notice and emerge more cost-effective and responsible. Having been dealt the difficult task of streamlining a traditional operating model – while at the same time improving client engagement and personal service – wealth management has been subject to innumerable changes. It is this delicate balancing act that has seen technology take centre stage and firms satisfy changing client behaviour.

Even the onward march of the digital age and the unerring spotlight of regulatory scrutiny has failed to topple an industry that has been caught in a financial storm. Last year wealth management in the retail sector posted its sixth consecutive annual increase in assets under management and productivity, with assets up 11 percent and revenues up six percent on the year last, according to PriceMetrix’s State of Retail Wealth Management report. Dating back to 2009, the upward trend is proof of the industry’s ability to negotiate sometimes-challenging market conditions, marking the beginning of a new era for global wealth management.

Less had been more
Previously the industry has been buoyed by fundamentals, the most notable being strong economic growth in emerging markets, booming equity markets and, crucially, a rise in HNWI ahead of GDP. It would appear, however, that as a result of increased regulatory and pricing pressures, firms are more selective about who they bring on board, choosing to serve fewer and, on average, more valuable clients.

Previously the number of clients per advisor in 2012 came to 159 – falling in 2013 to 156. Nonetheless, average household assets throughout the same period increased to $562,000 from $490,000, mirroring the same pattern in household revenue, which was up to $3,670 from $3,300. The number of HNWI with $2m or more in investable assets also increased by 19 percent in 2013 to 7.7 percent, an increase of 6.5 percent on the year previously and 5.7 percent in 2012. The findings illustrate where the focus lies for managers today, as they look to HNWI to compensate for heavy losses inflicted by way of regulation, increased IT spending and sky-high client expectations.

Whereas assets under management are back to their pre-crisis highs, and, in the case of most emerging markets, far and above what they were previously, the pressures on revenue and profits are far greater. Revenue growth and profitability – when put alongside equity market returns – is seriously short, and highlights the importance of transforming operating models if firms are to remain competitive.

The circumstances have seen technology emerge as the go-to solution for many of the prevailing issues, and without it, many firms would likely struggle to keep pace with new and established market players – not to mention rising client expectations and regulatory pressures. As a result, firms are upping IT spending and integrating data, channels, people and processes as they do so. One joint report co-authored by Wealth Briefing, Weatherill and Advent Software entitled Technology and Operations Trends in the Wealth Management Industry shows the extent by which firms are beginning to see technology as a pillar of effective wealth management. The report shows that 60 percent of respondents have or will invest up to $5m on technology a year over 2012, 2013 and 2014, around 10 percent will then be investing between 10 and $20m annually, and another 10 percent will invest over $10m.

Those asked in the survey also said that the biggest technology-related challenge they faced was compliance with present and future regulatory requirements, with transparency at a distant second. Meeting regulatory challenges, therefore, accounts for the biggest share of spending, above even cost cutting and security. “Client expectations with regards to technology are fundamentally changing – not only driven by how digitised the banking industry is, but also their experiences in other industries,” says Sid Azad, Partner and Financial Services expert at Strategy&’s London office.

Adapting to the unknown
One area in which technology has emerged as an important differentiator is in reporting. Customisation and autonomy in particular are key areas of focus, as clients increasingly demand that they have anytime anywhere access to their assets. Here digital channels are crucial in building integrated wealth management platforms, capable of withstanding the changes – regulatory or otherwise – that come the industry’s way.

The focus on digital strategy and the development of new wealth analytics tools has also given rise to new market entrants, whose understanding of the digital space sets them apart from established competitors. “The new players are significantly more configured for the digital age than the traditional players are,” says Azad. By automating various back-end processes, these technologically savvy newcomers can eliminate hefty back office costs and still deliver a comprehensive and always connected service to their clients.

“The new players are also better at putting clients in control of their portfolios and helping clients co-create their propositions rather than being offered the standard two or three propositions. These new players are often able to offer better price points due to a more nimble and technology enabled operating model,” he adds. As such, a digital strategy for those in wealth management is no longer a choice but a necessity if they are to satisfy clients, streamline operations, cut costs and increase compliance across the board.

Much like the rest of the financial services sector, wealth management has come up against a host of regulatory hurdles of late. One Strategy& report, entitled Global Wealth Management Outlook 2014-2015: New Strategies For A Changing Industry, shows that in Europe, regulations have driven up costs by five to 10 percent for wealth management firms, becoming the single most expensive operational consideration on the books. Although the new regulations have been introduced to protect against corruption and mismanagement, no other factor has troubled firms to such an extent.

“Greater transparency on fee and performance is resulting in a fairly fundamental shift in client expectations, and therefore their wealth managers,” says Daniel Diemers, Partner at Strategy&’s Financial Services practice in Europe and the Middle East. “Historically, clients have often not been fully informed and appreciative of the various charges built into their underlying investments, and therefore how they could influence management fees by changing their portfolios.”

Firms must now make public their tax arrangements, forcing many into rethinking their offshore strategies, and making improvements to client disclosure in order to protect against mis-selling. What’s more, new pricing laws should serve to significantly lower costs for clients in the near future, narrowing already slim profit margins further still. “Regulatory changes and lack of clarity on future regulatory pressures is one of the biggest concerns of wealth managers,” says Diemers. “We believe that regulatory compliance has already added at least 10-15bps onto on-going costs-to-do-business due to a significant need for remediation and the constant flow of work to adhere to new regulations.”

Clients, whose appetite for transparency has increased most notably since the financial crisis took hold, have also fuelled the regulatory changes. As opposed to previous years, clients are demanding full disclosure across the board and the option to make informed executive decisions on how their assets are managed. “While regulations are contributing to a more transparent and competitive private wealth management landscape to a certain extent, an even bigger driver of transparency is the emergence of nimble, fully transparent wealth and asset management technology platforms,” says Azad. “These platforms are setting new standards for transparency which traditional players are being forced to match. We expect this trend will continue and traditional players will need to fundamentally change their operating models to achieve a significantly lower cost structure so that they can compete in a more transparent environment.”

Regardless of consistent annual growth in assets under management, traditional wealth management firms are only now beginning to adjust to a transformed industry. By putting client- centricity ahead of profitability and focusing on solutions ahead of mere services, industry leaders are redefining the foundations and bringing an increasingly sustainable and responsible shape to wealth management.

To mark this transformation, World Finance recognises those leading the way and making clear changes in the wealth management space.

Since the global financial crisis in 2008-09, the sustained suppression of interest rates by global central banks has contributed to broad-based inflation in asset prices, rewarding investors that have participated indiscriminately in the prevailing yield chase in global bond markets.

Short-term interest rates continue to yield close to 0 percent, resulting in investors suffering negative real rates of return after adjusting for inflation for short maturity holdings. With the Bloomberg European High Yield Index offering investors a yield-to-worst figure of merely 3.4 percent at the time of writing, high yield no longer represents high yield, and investors are being forced to stretch for yield at the expense of duration, credit quality and liquidity.

With 2013 representing a true annus horribilis for bonds – with investment grade bonds suffering their worst year since 1994, registering their first annual loss since 1999 (only the third time in 34 years the asset class finished the year in the red) and long duration bonds suffering heavy losses in 2013, with the Barclays US Treasury Index 20+ Years maturities returning negative -13.88 percent – investors are being forced to reassess risk exposures in fixed income portfolios as the 30-year-plus bull market in bonds seemingly draws to a close.

From May 2 to June 25, 2013, the yield on 10-year US Treasuries went from 1.63 percent to 2.59 percent, causing sharp losses in fixed income portfolios, as investors priced in stronger US economic growth and the withdrawal of Fed stimulus. With consensus forecasts suggesting that the yield on the US 10-year Treasuries will rise to 3.5 percent by the end of 2014, more challenges lie on the horizon for bond investors, as they remain overexposed to interest rate risk. It is against this backdrop that Byron Capital Partners is aiming to provide innovative solutions in the area of absolute return fixed income and relative value credit, with a focus on producing strong risk-adjusted returns while offering investors a liquid alternative to traditional long-only fixed income investing.

The search for yield
Greece, after announcing the world’s largest sovereign debt restructuring in history in 2012, returned to the markets in April 2014 issuing €3bn of a euro-denominated five-year bond. An order book of €20bn drove yields down to a remarkable 4.95 percent, despite Greece’s credit rating (Caa3 from Moody’s and B- from S&P). Spain, rated Baa2 by Moody’s and with net foreign liabilities of 114 percent of GDP, in April 2014 issued a 10-year USD-denominated bond at a record low (since 2004) yield of 3.059 percent.

Not only have peripheral European countries profited from investors’ search for yield, but Pakistan is rated Caa1 by Moody’s and issued its first USD bonds since 2007 in April this year at a yield of 7.25 percent for the five-year maturity and at a yield of 8.25 percent for the 10-year bonds. Weaker creditors continue to come to the market to take advantage of low yields and strong buying from investors, who are desperate for yield. This demand has led to continual over-subscription of new debt issues, resulting in reductions in coupons and protections and less transparency provided to investors (issuers have even refused access to historical financials in some cases). Going further down the credit spectrum in search of return remains challenging, as even distressed names are in short supply. Taking the definition of a ‘distressed credit’ as a name trading in excess of 1,000 basis points over US Treasuries, only four percent of the US High Yield Index trades with spreads in excess of 1,000 basis points over US Treasuries.

Faced with corporate credit yields continuing to touch new lows and credit supply offering inadequate compensation for fundamental credit risks, traditional bond investors have been forced to turn to equities, but their volatility can be problematic. For example, since 1972 the S&P 500 has fallen more than seven percent on 27 occasions. Furthermore, incoming legislation such as Solvency II, which will regulate the €7trn European insurance industry, focuses on ‘asset risk’, forcing insurers to evaluate the assets they invest in from a cost and risk budgeting perspective. Under Solvency II, a capital charge of 39 percent will apply for global equities but debt-related instruments are scheduled to be cheaper at 15 percent, forcing insurers to look to debt assets. However, with yields low and investors being forced to take more duration and credit risk, investors are now being forced to look at absolute return fixed income and relative value credit as alternatives to traditional long-only fixed income investing.

Byron Capital Partners launched the Byron Fixed Income Alpha Fund in November 2010, which focuses on absolute return fixed income and relative value credit. Furthermore, the fund operates in a UCITS-compliant (undertakings for collective investment in transferable securities derivatives) structure, domiciled in Ireland. The strategy works well in a UCITS structure, although leverage in UCITS is limited to 10 percent of net asset value so the quality of the asset management is truly tested. In addition, exposure to loans that tend to outperform in a rising interest rate environment are not permissible in UCITS funds.

During and following the 2008 financial crisis, the comparative advantages of UCITS funds manifested themselves and the structure addresses prominent investor concerns such as liquidity, regulation, custody of assets, transparency and risk management. UCITS IV provided the flexibility for absolute return strategies to be run effectively in a UCITS structure with the scope to offer hedge fund-like risk-return profiles in a regulated, liquid and transparent product offering. Both in and outside of Europe, the UCITS directive has evolved into one of the most widely recognised regulatory frameworks of investment funds, allowing investors to access absolute return strategies through UCITS-compliant onshore structures while obtaining increased transparency and liquidity. One of the most effective measures taken by the UCITS directive to provide investor protection is the requirement for UCITS funds to hire independent service providers such as trustees, auditors, administrators and custodians. In addition, UCITS funds explicitly lie outside of the AIFMD scope and already possess a European passport allowing distribution across Europe.

Low risk, low volatility
Now approaching its four-year anniversary in November, the Byron Fixed Income Alpha Fund has won performance awards for 2012 and 2013 from leading industry publications in very different market conditions for fixed income investing. The fund returned 7.43 percent in 2012 and 3.47 percent in 2013 and has run an average credit rating of BBB since inception, thereby not taking excessive credit risk. For the year-to-date through May 15, the fund has returned 2.69 percent.

Duration risk continues to be tightly managed, with the fund running duration at 1.95 at the time of writing. Furthermore, volatility is low at approximately 2.3 percent since inception and a premium is placed on risk management, with monthly value-at-risk at a 99 percent level of confidence currently totalling 1.39 percent. Hit ratios of individual trades (i.e. each trade is monitored for profitability) are monitored and stored for analysis and correspondence with the risk team. A strong emphasis is placed on matching the liquid profile of the investments with investor capital, in line with the UCITS directive. On account of offering investors weekly liquidity, the fund maintains a liquid portfolio of investments in order to ensure there are no mismatches between investor capital and the underlying asset base of the fund.

Importantly for investors looking to mitigate interest risk and diversify their fixed income portfolios, the fund maintains a low correlation against traditional bond indices, with a correlation of less than 20 percent versus the Barclays US Aggregate Bond Index. The selection of securities held is bottom-up driven, with the goal of identifying fundamentally mispriced idiosyncratic risk. Generation and implementation of short side exposure is more top down, macro-driven with the focus on identifying asset class, sub-asset class, sector or sub-sector shorts either to hedge out exposures in the long side of the book or express a negative view on a particular segment of the market. Themes on the short side that worked well in 2013 included but were not limited to shorts in US Treasuries that helped mitigate interest risk. The fund has historically been run with a net long exposure but has the ability to take a net short exposure that should serve it well in a secularly negative environment for fixed income and credit. In terms of current opportunity sets, the investment management team is focusing on selective areas of emerging markets following the re-pricing of emerging market risk in 2013.

With short-term interest rates in the developed world likely to remain low for the foreseeable future, a premium will be put on the ability to generate positive real returns without exposing investors to excessive duration and credit risk, as well as illiquidity. With the 30-year-plus bull market in bonds reaching a denouement and investors under increasing pressure to produce positive real returns from fixed income investments, the prospects for absolute return fixed income, particularly in a regulated structure, look favourable and offer a compelling alternative to a rotation into equities that arguably remain expensive on both a cyclically-adjusted and historical basis.